2008 Sector Outlook: Technology

The fifth in a series examining the outlook for five sectors. S&P analysts have just one overweight recommendation: information technology

From Standard & Poor's Equity Research

How do key S&P 500 sectors stack up for 2008? Here is the fifth in a series examining the outlooks for five S&P sectors: the four with marketweight recommendations that have the largest market cap weightings in the S&P 500 index— and the one sector with an overweight recommendation. A selection of five of S&P's top-ranked stocks in each sector will also be featured.

Information Technology

Sector Recommendation: OVERWEIGHT

S&P 500 market cap weighting: 16.5%

S&P recommends overweighting the S&P 500 Information Technology sector. Year to date through Nov. 23, the S&P Information Technology Index, which represented 16.5% of the S&P 500 Index, was up 12.2%, compared to a 1.6% gain for the S&P 500 Index. In 2006 this sector index increased 7.7%, vs. a 13.6% rise for the 500. There are 14 subindustry indexes in this sector, with Computer Hardware the largest, at 23.7% of the sector's market value.

S&P's fundamental outlook on the IT sector is positive. In recent weeks a number of IT companies have indicated demand has been quite healthy, notwithstanding the potentially adverse impact of continued U.S. housing weakness and the credit squeeze.

S&P sees more stable semiconductor pricing and inventories, notably sales of computers and lower-end servers, and favorable trends in storage hardware and software. One of the major trends we see for next year is continuing strength in PC-related revenues, reflecting major new hardware and software offerings, appealing pricing, and strong international demand, said Scott Kessler, head of technology equity research. We think enterprise spending growth will remain solid, aided by the continuing adoption of Microsoft's (MSFT) Vista operating system through 2008.

Healthy Growth Abroad

Some other trends we see for next year include the emerging importance of solar power companies, demand for storage hardware and software, the increasing prevalence of converged devices, and the proliferation of Web services.

Another important theme for 2008 is international operations and sales. We expect the U.S. economy to slow, but anticipate sustained healthy growth abroad.

The sector index is projected to post a 24% increase in 2008 operating EPS, vs. a 15% advance for the S&P 500. The sector trades at a p-e on estimated 2008 EPS of 18.8, vs. 13.9 for the S&P 500. Its p-e to projected five-year EPS growth rate of 1.1 is equal to the broader market's PEG of 1.1. This sector's marketweighted S&P STARS average of 3.8 (out of 5.0) is above the average of 3.7 for the S&P 500.

Neutral with a Positive Bias

Our technical opinion on the S&P 500 Information Technology Index remains neutral with a positive bias. The sector was hit pretty hard over the last couple of weeks, but has held at trend line, with support drawn off the highs since 2004. The index has also dropped right to its 43-week exponential average, another key support. The sector is close to the weekly closing lows from August, another zone that could provide a floor for the index, by our analysis. Relative strength vs. the S&P 500 remains in an uptrend that started back in July, 2006, despite the recent price weakness. Weekly MACD has rolled over below its signal line, a warning, but MACD remains above zero. The 14-week RSI has backed off from overbought territory but has yet to reach oversold levels.

With U.S. economic growth slowing, we believe the IT sector's above-average international revenue exposure positions it to outperform, as S&P expects overseas economic momentum to remain robust, especially in emerging markets.

Our top picks, or those stocks ranked 5 STARS (strong buy, as of Dec. 12) include Microsoft, Oracle (ORCL), IBM (IBM), eBay (EBAY), Corning (GLW), Automatic Data Processing (ADP), Seagate Technology (STX), Citrix Systems (CTXS), Netgear (NTGR), Logitech International (LOGI), Shanda Interactive Enter ADS (SNDA), Cognizant Tech Solutions (CTSH), Cymer (CYMI), and MEMC Electronic Materials (WFR).

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