Buying the Up Cycle as IT Heads for the Clouds

On balance we tend not to make big sector bets, now we do like information innovation as a niche strategy for this year. We think that there are considerable benefits across the sector and we’re hopeful that this position, which we put into all four of our model portfolios back in early 2010, will continue to add additional alpha.

We have been using Vanguard Information Research ETF exclusively to fulfill this mandate. During there are other alternatives at different capitalization ranges and across other subsectors, we like the exposure via a broader based cap-weighted index just as this. To our way of thinking, if investors can garner returns in this cap range, they’d prefer to secure those gains with the larger-cap names in this segment of the sector than to hunt and peck in a swath of lesser-known names and leaner market caps. The 2008 anxiety hangover can be calmed somewhat with the familiarity of near 98% coverage of the U.S. market cap.

Our belief is that the larger-cap/broader exposure makeup of this fund gives investors something easier to recognize. This, we feel, will make our job of keeping them invested considerably easier, as we can balance any short-run volatility with a purposeful conversation on company quality and proven track records; as opposed to trying to rationalize lesser-known products, companies and lines of business.

The overall sector view we believe is that one of the first areas that will benefit from a loosening of the purse strings is IT. First, it had been one of the hardest hit when corporate cutbacks came in; secondarily, we think that the view is, in some cases, that it’s easier and cheaper to let research pick up the work-to-worker productivity gap than it is to add jobs and increase payroll.

We think that there will have to be some cannibalization in the sector; the shift from mainframe computing to cloud-based computing has inherent in it some pragmatic difficulties. The positive is that we think that the consumer side of the demand is likely to be even higher than the corporate side, as expenditures heat up to both keep pace with the content flow and prove a worthy alternative to travel, vacations and buying bigger and bigger televisions and sound systems.

Also, the shift in social media vs. "Web-based" enhances the market for "walk-n-talk" devices just as smartphones and tablets like the Apple iPad.

We remain cautious in the regard that in this sector as with the overall market, it’s easier to imagine things going wrong than it is to imagine any single thing going particularly right. Nevertheless that being said, we think that the "top-heavy" nature of this ETF can be a concern, there’s a high concentration in the largest holdings and we think that the onslaught of "cloud computing" might prove to be a shorter-term impediment, yet a potential game-changer everything considered.

The top-heaviness a little

Let's delve into the top-heaviness a little. More than 25% of VGT's success has been tied up in Apple, Microsoft and IBM. As those firms go, so go all the broad tech ETFs. For those bullish on the sector, do you think there's any added benefit to be had from subsector funds, like hardware or semiconductors?

What we love about the broader story is that it’s easier for a broader audience to relate to the overarching theme. They’re bombarded with research-related news and advertising and you can make a pretty rational case for the sector without having to delve too far into "what’s in accordance with the hood."

InformationWeek's survey says 55% of firms expect to increase IT spending this year, most of them by more than 5% - with much of the increase going to services. VGT is correlated fairly so then with the Innovation Select Sector SPDR, nevertheless is heavier on services firms vs. XLK's exposure to telecoms; might VGT be a more pure play on services spending?

The services spending play

We do think that VGT is strongly positioned to take advantage of the services spending play. At our own firm, our IT budget has gone through a dramatic change with a shift almost in every way out of hardware and support to cloud computing and services. As that’s happened, our system configurations and devices have had to keep pace; we’ve been in on every iteration of the iPhone and iPad and however consider them necessities.

While the sector may to some extent be able to drive activity within its own ranks, merely trading goods amongst the sector itself might be "activity" now we don’t know that it’s the kind of activity that necessarily impacts the bottom line of anyone of any import. On the corporate side, we think that the potential for "skimping" is far less likely, with "roles" and "goals" needing to be met across the corporate platform. At present we see research as a so then entrenched representative in the fight for profitability and increased market share.

The economics in general

While we think that corporate buyers might be more sensitive to the economics in general and thereby reduce spending if we have any substantive retrenchment in the economy, we don’t see this having as big an impact with the general consumer, because of the amount of content in other words being created for use on consumer devices. With the continued production of "apps" of all kinds across mobile phone, tablet and even nevertheless desktop configurations - as then as conventional media’s continued foray through sports, movies, music and more - we think that the consumer’s appetite for these services will continue to increase and the desire to have the newest and most efficient devices on which to use these configurations will only increase. With Verizon’s debut of the iPhone upon us, the rumors of iPhone 5 in summer, and a possible new iPad previously year end, the race in the consumer sector seems to have no real end in sight.

While corporate IT departments may make do with what they have - or scale substantive changes into out years when they expect revenue projections to be better, or until further notice more stable - again, we think that there’s more of a chance of a "stall" in spending, corporate vs. personal.