Don't Toast IT Services Just Yet

Despite near-term relative strength, S&P believes the investment outlook for the IT Consulting index is neutral over the next 12 months

From Standard & Poor's Equity Research

A recent addition to the is the S&P 1500 IT Consulting & Other Services sub-industry index, which consists of 12 large-, mid-, and small-cap companies. During 2005, this sub-industry index fell 2.6%, vs. a 10.0% advance for the S&P 1500. So far this year, however, the group is up 18.6% to the market's 5.0% gain.

The relative strength chart () also looks positive. The jagged blue line represents the sub-industry index's rolling 52-week price performance compared to the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, and the two green bands indicate one standard deviation above and below the sub-industry index's 14-year mean relative strength.

Despite the near-term strength, Dylan Cathers, S&P's IT Services analyst, is neutral on the investment outlook for the group. He believes that increases in technology spending on consulting and infrastructure-based services will rise slightly in 2006. According to a survey by IDC Research, a global industry provider of IT data, spending on U.S. outsourcing services is expected to increase at a compound annual growth rate of 7.1% between 2005 and 2010. Worldwide, IDC expects services spending to increase 5.7% and consulting services spending to increase 4.8% annually between 2005 and 2010.


  Computer-services companies provide an array of offerings, including application development, strategy consulting, and Web site creation. Cathers thinks comments from companies in the IT Consulting sub-industry index indicated a moderate upswing in demand for consulting and outsourcing that began in the latter half of 2005. He believes U.S. companies are witnessing this to a large degree, but to a lesser extent in Europe. Furthermore, S&P thinks this trend will continue for the remainder of 2006.

Cathers sees modest near-term growth prospects and believes some IT services companies will look to supplement growth via acquisitions and partnerships. Another strategy S&P thinks is gaining momentum involves focusing on smaller and shorter-duration IT service contracts, which often involve reduced up-front costs and provide a faster return on investment.

The analyst anticipates that consulting and systems integration projects will continue to show some improvement in 2006. In the government marketplace, he views increased spending on defense and homeland security initiatives as positive factors, since many IT services companies have expertise in this area.


  Longer term, Cathers thinks computer services concerns will continue to benefit from the effects of an increasingly global economy, deregulation, an IT labor shortage, e-business opportunities, and what S&P views as a constant need on the part of corporations and governments to use services and systems that can help boost productivity and cut costs. Cost-cutting initiatives will likely be a source of strength for the India-based outsourcing companies in the group, in Cathers' view.

So there you have it. Despite near-term relative strength, S&P believes that the fundamental investment outlook for the S&P IT Consulting sub-industry index is neutral over the coming 12 months.

Source: Standard &Poor's

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), along with a stock that has the highest S&P STARS rating (tie goes to the issue with the largest market value).

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