Even the most bullish strategists believe the current rally in stocks is due for at least a temporary pause, so the market’s midweek stumble yesterday shouldn’t come as too much of a surprise. Moody’s warning on Thursday that it could slash the credit ratings of 17 major global financial firms is just the sort of news that reminds folks how tenuous the global financial sector remains. Such concerns have previously led to temporary pullbacks ever since the market’s remarkable run began more than four months ago.
Even so, investors regained their bullish legs in early Thursday trading, thanks to some further positive economic and employment reports.
Wednesday’s weakness notwithstanding, BlackRock‘s (NYSE:BLK) Bob Doll, Raymond James‘s (NYSE:RJF) Jeff Saut and Liz Ann Sonders of Charles Schwab (NYSE:SCHW) are just a few of the canny optimists who’ve done well for their clients by remaining bullish through the ongoing eurozone anxiety and credit downgrades since the rally kicked off back in October. Despite some fits and starts, the S&P 500 is up more than 20% from its 52-week low hit on Oct. 3, and has gained nearly 7% for the year to date.
“The run won’t last forever, and it won’t be straight up, but it could last longer than many think,” Sonders says in a new note to clients.
The key to the current rally is that the so-called “risk on” trade is back in force. Riskier assets like stocks are beating bonds, while within equities, riskier, more economically sensitive sectors are crushing the defensive names.
As we noted recently, active investors who hope to generate market-beating returns need to think about tactical sector rotation, whereby they overweight the offensive areas of the market and underweight the defensive sectors. If dividend-payers, low-yielding bonds and cash are out, then early-cycle sectors like financials and tech, which move ahead of any pickup in the broader market, will continue to shine.
For the most aggressive investors, however, careful stock-picking within the pro-cyclical sectors is the surest way to generate outsize returns during the risk-on trade. And when it comes to outperformance, no sector is doing better than technology stocks.
In addition to being early cyclical, tech is attractive because it’s not as exposed as financials are to headline risk every time a ratings agency threatens or enacts a downgrade. Financials are hypersensitive to eurozone and credit anxiety. Tech stocks, less so — especially now that fears of any economic slowdown look to be baked into tech-sector share prices.
How else to explain the bargains to be found even after the tech sector’s hot run? Techs have been the market’s best sector performer so far this year, rising 12% on a price basis, according to Standard & Poor’s. And yet valuations remain compelling among many large-cap names.
Tech’s outperformance is due in no small part to Apple (NASDAQ:AAPL). The world’s biggest company by market cap (and therefore the stock with the heaviest weighting in the S&P 500) is up 23% so far this year.
And yet even at nearly $500 a share, Apple still looks like a buy, at least by relative valuation measures. Shares still trade at nearly a 50% discount to their own five-year average on a forward earnings basis, according to data from Thomson Reuters, and offer a 33% discount by trailing earnings.
Dow component Intel (NASDAQ:INTC) is another mega-cap tech stock that looks compellingly priced. Shares are up nearly 10% on the year, and yet still trade at deep discounts to their own five-year averages by both forward and trailing earnings, according to Thomson Reuters data.
The same can be said of Dow component Microsoft (NASDAQ:MSFT) — another large-cap tech that’s up for the year and yet cheap on a forward and trailing earnings basis. InvestorPlace contributor James Altucher chose Microsoft as his top stock pick for 2012, and so far it’s been a rewarding play. Shares are up nearly 16% on the year, and yet the stock still trades 15% below its own five-year average price-to-earnings (P/E) ratio. That suggests more upside ahead.
Even long-struggling Hewlett-Packard (NYSE:HPQ), another Dow component, offers similarly compelling valuations, according to Thomson Reuters data. Despite its well-publicized management missteps, it has a share price that’s up a market-beating 13% in 2012. Shares offer discounts of about 35% to their own five-year averages by both trailing and forward P/E.
A cursory glance reveals that large-cap tech is littered with names that are both outperforming the broader market and still look like bargains. Aggressive stock-pickers who remain leery of the risk-reward profile offered by financials might do well to take a closer look at blue-chip technology stocks.