By Tom Smith, CFA
On Aug. 19, Standard & Poor's upgraded its recommendation on the information technology sector to overweight from marketweight. S&P's economic team sees a strengthening U.S. economy over the next 12 months, with improved job figures. S&P also expects gross domestic product growth to accelerate, from an estimated 2.4% in 2003 to 4.1% in 2004, 3.9% in 2005, and 3.1% in 2006. Moreover, the expectation is for technology equipment investment to rise more than twice as fast as the overall economy in each of those three years. It's worth noting that S&P's annual growth forecast for IT spending in 2004-06 -- somewhere between 8.5% and 9.5% -- is about half the rate witnessed in the boom era of the late 1990s.
Another reason for the upgrade: improving conditions in the tech sector. S&P's nine technology and telecommunications analysts observe low inventories of tech goods, increasingly evident equipment obsolescence, and early signs of improved orders.
Many investors have been snapping up tech stocks in hopes of a recovery. So far this year, through Aug. 14, the S&P Information Technology index has gained 23%, vs. 12.6% for the broader S&P 500 stock index. Internet software and services stocks have led the way, with a 61.8% surge year-to-date, followed by computer storage and peripherals, up 52.9%.
We think semiconductors will lead the sector's expansion, while telecom equipment will lag. In general, semiconductor stocks -- which have already risen 48.3% in 2003 -- are usually the first group to move higher in anticipation of an economic recovery. On the other hand, the telecom industry built up an extensive infrastructure in the boom years that's still sufficient to meet present demand. Plus, telecom service providers are awaiting improvement in the regulatory environment before they make capital spending decisions.
Our buy-ranked picks include Intel (INTC ), Vishay Intertechnology (VSH ), IBM (IBM ), Cisco Systems (CSCO ), ATMI (ATMI ), Microsoft (MSFT ), Sybase (SY ), DoubleClick (DCLK ), and Affiliated Computer Services (ACS ).
Among telecom-related companies, S&P has buy recommendations on shares of Intrado (TRDO ), Nextel (NXTL ), and Nokia (NOK ).
Analyst Smith follows semiconductor stocks for Standard & Poor's Equity Research Services