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Use ETFs to ride the tech takeoff
The energy boom is bound to cool off soon, while technology is just heating up. Exchange-traded funds, or ETFs, offer a way to play the overall sector or just select pieces of it.
By Timothy Middleton
Technology is taking off. And one way to play this and other sector moves is exchange-traded funds -- ETFs.
Sector rotation is one of the most seasoned investment strategies because conditions invariably favor some groups over others. Most mutual fund managers practice some form of it, with the momentum school climbing aboard hot groups and value players accumulating those out of favor.
ETFs are superb trading vehicles for sector investors because they trade like stocks. They can be bought on margin, using a loan from the broker to leverage up exposure to a group, and sold short, or borrowed and sold in the expectation of buying later at a lower price.
They can also be traded quickly, without fear of running afoul of a mutual fund company's redemption fees or rules against frequent trading.
And they're available in two forms -- broad portfolios covering an entire group and industry portfolios that target, for example, software, which has provided the biggest gains so far in the emerging tech rally.
Riding oil prices
The hottest area now is energy, because oil prices have topped $50 a barrel and show signs of lingering on that lofty plateau. But the easy money there has been made. Technology strikes me as the play of the moment, because after lagging the market for months, it's leading.
Related news and commentary on MSN Money  | |
"This past month we sent out a report entitled, 'Is the tech rally for real?,' where we highlighted: one, a seasonal trend in tech outperformance; two, historically moderate valuations; and three, oversold conditions, which could contribute to a tech rally in (the fourth quarter)," write analysts Jim Floyd and Patrick Magnusson of Leuthold Group Institutional Research.
"Oversold" is Wall Street argot for pressured sales, such as those of mutual funds trying to erase losing positions from their annual reports, most of which will be dated Oct. 31.
"This rally may already be under way," Floyd and Magnusson concluded in the firm's October report to clients, which include all the top Wall Street firms.
| An ETF shopping list | | Sector | 3-month performance | YTD perf. | 3-year perf. | | Telecommunications | | | | | iShares Global Technology (IXP, news, msgs) | 8.1 | 4.7 | n/a | | iShares Dow Jones US Telecommunications (IYZ, news, msgs) | 13.0 | 13.3 | - 7.7 | | Natural Resources | | | | | Energy Spider (XLE, news, msgs) | 6.7 | 27.5 | 11.0 | | iShares Tr Energy Sector Index (IYE, news, msgs) | 6.6 | 26.0 | 12.3 | | iShares Goldman Natural Resources (IGE, news, msgs) | 5.3 | 17.4 | n/a | | iShares S&P Global Energy (IXC, news, msgs) | 6.0 | 19.9 | n/a | | Vanguard Materials Vipers (VAW, news, msgs) | 2.6 | n/a | n/a | | Technology | | | | | SPDR Technology Sector (XLK, news, msgs) | 4.0 | - 3.6 | - 1.8 | | iShares DJ US Sector (IYW, news, msgs) | 2.3 | - 8.8 | - 0.5 | | StreetTracks MS High Tech 35 (MTK, news, msgs) | 2.3 | - 5.2 | 1.9 | | iShares GS Tech (IGM, news, msgs) | 1.4 | - 8.4 | - 1.0 | | iShares GS Networking (IGN, news, msgs) | 2.1 | 1.7 | - 0.6 | | iShares GS Semiconductor (IGW, news, msgs) | - 4.2 | - 23.6 | - 4.8 | | iShares GS Software (IGV, news, msgs) | 10.7 | - 2.9 | 0.8 | | iShares S&P Global Info Tech (IXN, news, msgs) | 1.9 | - 4.1 | n/a | | Vanguard IT Vipers (VGT, news, msgs) | 1.5 | n/a | n/a |
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Note: As of Oct. 18.
Source: Morningstar Inc.
The top-performing ETF among technology funds at the moment is iShares Dow Jones US Telecommunications (IYZ, news, msgs), up 13% in the three months ended Oct. 18. It has 43% of its assets in just two telephone stocks, Verizon (VZ, news, msgs) and SBC Communications (SBC, news, msgs).
And in second place
Second best has been iShares Goldman Sachs Software Index (IGV, news, msgs), up 10.7%. Its top position, at 10% of assets, is Microsoft (MSFT, news, msgs). (Microsoft is the publisher of MSN Money.)
But other tech groups are starting to catch up. The proxy I use for technology in the model portfolio I maintain here is the Nasdaq-100 Trust (QQQ, news, msgs). That ETF was badly lagging S&P 500 Spiders (SPY, news, msgs), the ETF that represents the broad market, this year until the closing days of September, when it began to zoom ahead.
That tech should stage such a rally now isn't surprising. The fourth and first quarters are traditionally the group's strongest period, because that's when corporate tech spending is most strongly reflected in their stocks.
Standard & Poor's Monthly Investment Review for October rates the information technology sector 3.8 stars on a scale where five is a "buy" and one is a "sell." The rating isn't far behind the 4.2 it assigns to energy.
Turning away from energy
But my opinion is that now's the time to sell energy funds. Oil is just a commodity and one of its strongest buyers, China, is tightening its economic belt at the same time the U.S. economy's recent steamy growth is moderating.
"Over the next six to 12 months, I believe that the recent surge in the price of a barrel of crude oil to $55 a barrel is more likely to be followed by a drop to $40 a barrel by the end of the first quarter of 2005 than a move to $70 or higher," says Ed Yardeni, chief investment strategist of Oak Associates.
Bold investors could play a decline in energy by shorting the Energy Spider (XLE, news, msgs) or iShares Dow Jones US Energy (IYE, news, msgs), both of which have nearly half their assets in just three oil companies, Exxon Mobil (XOM, news, msgs), ChevronTexaco (CVX, news, msgs) and ConocoPhillips (COP, news, msgs).
That's assuming you can short them: Each is among the smaller ETFs, with market caps of less than $500 million, and the Dow Jones fund barely trades. The smaller a stock's float, the harder it is to find shares to borrow.
In my personal portfolio, I have long-term commitments to only three sectors: technology, health care and financial services. Each has beaten the market over the last two decades, and I expect that performance to continue.
But I don't think health care and finance will prosper in the next six months or so. The former is weighted down by troubles at the biggest drug makers, and none of them has a pipeline flush with new miracle drugs. The latter faces higher interest rates, which squeeze margins, and incendiary charges of self-dealing against the insurance industry.
Taking profits
I have made one change to these sector holdings, and will make another three days after this column is published.
Several weeks ago I trimmed a position in one of the few common stocks I own, Qualcomm (QCOM, news, msgs), author of the CDMA technology used in wireless communications. Defying the group, it has been strong all year, splitting 2-for-1 back in August. It was up about 55% when I sold one-fourth of my shares, simply to lock in some profits.
This week I will sell my financial services fund and use the proceeds to buy a tech fund, probably SPDR Technology Sector (XLK, news, msgs). The Spiders largest positions are Microsoft, Intel (INTC, news, msgs), Cisco Systems (CSCO, news, msgs), IBM (IBM, news, msgs) and Verizon. Aside from its current superior performance, it is less volatile than most technology ETFs.
The net effect will be to eliminate financial services, increase tech exposure correspondingly and maintain health care. In the context of the total portfolio, the changes affect less than 5% of assets, so its hardly a big bet, but it seems a worthwhile tweak.
Volatility is the bane of cyclical industries like technology, which gave us the tech bubble and its costly bursting. Own it forever, if you're a long-term investor, or own it for the next six months, if you're not.
At the time of publication, Timothy Middleton owned the following securities mentioned in this article: Microsoft, Qualcomm, Cisco Systems.
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