Bob’s Journal for 07/11

The technology sector is changing in ways that investors need to know.

Technology has been the leading sector in the economy for some time. The growth and innovation in the sector has been a significant contributor to overall economic growth.

Developments in tech have benefited most sectors of the economy. Companies have become more competitive and efficient because of innovations in the technology they use. 

The tech sector also has been an important contributor to stock index returns over the last few decades, but especially over the last 10 years. Technology stock prices are rising so rapidly that tech is nearing 30% of the S&P 500.

Fans of index investing like to point out the high returns an investor would have earned simply from buying and holding a broad-based index such as the S&P 500. 

But tech stocks dictate much of the ups and downs of the major indexes and their returns. A buy-and-hold investor would have done much better investing only in the technology sector instead of the broader index.

Many investors don’t realize that tech companies are cyclical. Investors generally think of cyclical stocks as old-line manufacturers and materials companies. Caterpillar (CAT) is the classic example of a cyclical stock. 

Technology companies, however, make most of their sales to other businesses and to governments. Only a few tech companies primarily sell directly to consumers. 

Because a high percentage of tech sales are to businesses, technology company revenues rise and fall with economic growth. When businesses reduce expenses and expansion plans because of worries about economic growth, new technology purchases often are the first expenses to be cut.

We saw this in action in the last quarter of 2018, when there were concerns the economy was heading toward a recession. Tech stock prices suffered the most in that quarter, and they bounced back the most once the recession fears subsided.

The latest development investors need to consider is that the major tech companies now are aggressively competing with each other.

In the past, tech companies generally were regarded as innovators who were creating new markets and expanding the economy. 

There’s still some of that happening. But tech companies, especially the larger companies, are innovating less. They’re competing against each other to provide similar products and services to governments and large companies.

A recent headline from the AP captured this trend: “Amazon, Microsoft wage war over Pentagon’s ‘war cloud.’”

Amazon, Microsoft and IBM offer similar cloud-based services to governments and businesses. They compete against each other for winner-take-all contracts to provide the services. 

Another example is Shopify. It competes primarily against Amazon to provide online “storefronts” to small businesses who want an online retail presence. Shopify provides an easier process for businesses than Amazon and allows branding opportunities that Amazon doesn’t, among other benefits.

Technology will continue to boost economic growth and be a major sector in the stock market. The big name companies, however, might not deliver the profit growth and stock gains of the past. They’re going to spend more time fighting to divide the existing pie and less time expanding the size of the pie through innovation.

The Data

Small business owners still are positive, though they were a little less so in June than in May, according to the Small Business Optimism Index from the National Federation of Independent Business (NFIB). The index declined to 103.3 from 105.0. The owners are concerned about both trade conflicts and slowing global growth. They have reduced expectations about earnings, sales, capital investment and employment.

Last Friday’s Employment Situation reports relieved some fears that economic growth was slowing rapidly. The reports were so good that some investors began to worry that the Federal Reserve might not reduce interest rates as much as investors want.

The reports said 224,000 new jobs were created in June, compared to 72,000 in May. Over three months, which is a better way to look at this volatile number, the number of jobs created indicates growth has slowed from 2018 and is stabilizing at a moderate level. 

A deep dive in the data reveals that the decline in jobs growth in recent months is concentrated in sectors that are affected by trade conflicts and tariffs and slower growth outside the United States.

Households continue to do well, according to the reports. Wage growth was up 0.2% for June and 3.1% over 12 months. The average work week was unchanged.

The JOLTS (Job Openings and Labor Turnover Survey) report is more detailed than the Employment Situation reports and is a month behind. The latest JOLTS report tells a similar story as the Employment Situation reports. We still have a very high level of job openings, but fewer than several months ago. The number of new hires also declined. The number of workers quitting their jobs has been roughly the same all year and is a moderate 2.3% of the work force. 

The Markets

The S&P 500 rose 0.26% for the week ended with Tuesday’s close. The Dow Jones Industrial Average edged up 0.07%. The Russell 2000 added 0.16%. The All-Country World Index (excluding U.S. stocks) lost 1.21%. Emerging market equities fell 1.78%.

Long-term treasuries declined 0.53% for the week. Investment-grade bonds fell 0.96%. Treasury Inflation-Protected Securities (TIPS) rose 0.08%, while high-yield bonds lost 0.33%.

In the currency arena, the U.S. dollar increased 0.80%. 

Energy-based commodities rose 2.02% and broader-based commodities added 1.56%. Gold lost 1.26%.

Bob’s News & Updates

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