Does the Tech Sector Deserve to be Treated Differently?
The recent outperformance of tech stocks relative to the broad equity market has helped fuel the notion that this sector deserves to be treated differently.
It’s a tempting idea, and one that’s been bubbling for some time. The recent outperformance of tech stocks relative to the broad equity market has helped fuel the notion that this sector deserves to be treated differently.
“Technology wasn’t unimportant before COVID-19. But the pandemic and associated lockdowns have changed the calculus,” writes Duncan Stewart, an analyst at Deloitte Canada. In a thought-provoking article published by the CFA Institute, he lays out the case for seeing tech as something more than just another equity sector.
Increasingly, the question is not whether tech is important — it is — but just how important? What percentage of its time should a bank or retailer’s C-suite spend thinking about technology? How much of its annual spending should a firm allocate to tech? Twenty years after the dot-com bubble popped, what weighting should institutional and retail investors give the sector?
Tech certainly deserves a role in most if not all investment portfolios. But making the leap to carving out a distinct role for these stocks as asset class is still open for debate. It’s premature to dismiss the idea, but it’s not yet clear that it’s time to go all-in either. Deeper analysis is needed.
Let’s start with a quick look at how Mr. Market prices tech relative to the usual suspects across the asset class spectrum by way of return correlations. As proxies for the tech sector, we’ll use four ETFs, including Invesco QQQ Trust (QQQ), which is loaded up with the likes of Apple, Microsoft and Amazon. For additional perspective, we’ll also slice and dice by a broad sector-based measure (XLK) and three industry subsets: software (XSW), internet (XWEB), and semiconductor (XSD).
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The question is whether tech exhibits a noticeably lower return correlation vis-à-vis the broad stock market (SPY) and other conventionally defined asset classes: US bonds (BND), real estate/REITs (VNQ) and commodities (GCC)? Correlation alone doesn’t answer the asset class question, but it’s an obvious place to start.
On that basis, the first table below suggests that tech stocks remain closely tied to the ebb and flow of the stock market generally, based on daily correlations for the past three years through yesterday’s close (Feb. 2). Broad tech (XLK) and the QQQ fund post the highest correlations for the tech proxies vs. the overall stock market (SPY) with 0.94 and 0.93 readings, respectively. (Note: correlations range from 1.0, perfect positive correlation, to zero, no correlation, to -1.0, which is perfect negative correlation.
At the lower end of the tech/US stock market correlation pairings is 0.77 for internet-focused shares via XWEB/SPY.
For comparison, here’s how the trailing one-year correlations stack up: