Why Are Tech Stocks Flirting With a Correction?

by Dan Burrows | July 11, 2012 10:45 am

By one key measure, tech stocks are a just a couple percentage points away from falling into a full-on correction.

The popular Select Sector Technology SPDR (NYSE:XLK[1]) is off nearly 8% from its most recent peak, while the broader market is down just 5% from its own respective high.

So what gives? Partly it’s just the simple fact that when it comes to equities, the higher they fly, the harder they fall. XLK gained as much as 20% at one point in 2012, while the S&P 500 stalled out with a comparatively small 13% gain. Tech stocks simply had more profits to pocket.

Note well that it’s not as if XLK has been a bad bet so far this year. It’s still holding onto a price gain of nearly 11%, beating the broader market by about 4 percentage points.

But the sharp drop since late March does warrant closer scrutiny, especially given technology’s position as a bull-market leader.

On a broader level, tech stocks are struggling because of the market’s abrupt shift back to more defensive names and sectors — the so-called “risk-off” trade. The European debt crisis, sluggish growth on the continent and slower expansion in China have investors seeking safety.

That’s helping the more defensive sectors and hurting offensive, pro-cyclical stocks. Like financials and consumer discretionary names, tech stocks tend to lead when the market’s going up and lag when it’s coming back down.

So it’s no surprise that during the past three months, the highly defensive sectors of utilities and health care are leading the market higher, with gains of about 6% and 4%, respectively — and that the tech sector is off more than 5% during the same period.

It also doesn’t help that, heading into earnings season, tech is forecast to grow earnings only 3.3%, according to data from FactSet — and that almost all of that growth is due to Apple (NASDAQ:AAPL[2]).

Indeed, if you strip Apple out of the results, the earnings growth rate for the tech sector falls to -2.4%, and the sales growth rate falls to 3.2% from 6.3%. That hardly gives tech stocks a head of steam heading into earnings.

Furthermore, as the world’s biggest company with a market cap of more than $570 billion, Apple naturally has the biggest weighting in XLK, accounting for almost 20% of assets. As such, Apple has a lot of sway over the direction of the ETF — and the iPhone maker’s stock has been fairly rangebound.

Apple peaked at $636 in early April, slid to $530 by mid-May and now goes for about $610. Microsoft (NASDAQ:MSFT[3]) and IBM (NYSE:IBM[4]), the second- and third-largest components of XLK, have likewise been stuck in a trading range.

It’s awfully hard for tech stocks to rally without three of the biggest names leading the way. And with the market on a defensive footing until the macroeconomic news improves, well, tech remains under a tight leash.

Unless the sector can deliver some big upside surprises and better-than-expected forecasts when profit reports roll in, investors might find catalysts hard to come by.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2012/07/why-xlk-flirting-with-correction-aapl-ibm-msft/

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