Coming into this year our analysis of general conditions dictated that we maintain a moderate target weighting (presently 14% of equities) to technology. That’s despite the huge momentum the sector had coming into the year, and our acknowledgement of the S&P 500’s historically high weighting (presently 26+%) to the sector. We reference the latter because we recognized that we would likely under-perform the S&P should tech continue its epic run.

Well, with tech up 13.9% year-to-date, and our top three weightings, financials (17% target), industrials (16% target) and materials (15% target), up 0.69%, 0.63% and down 3.98% respectively, while most of our portfolios (adjusted for their equity exposure) have outperformed the New York Stock Exchange Composite Index year-to-date, they’ve under-performed the tech-heavy S&P 500. Again, given that we’re uncomfortable with the risk/reward profile of a 26% weighting to tech, we’re comfortable with our notably lower position and our less-than-S&P 500 results thus far this year.


For more texture on why we’re maintaining a modest weighting to a red-hot sector, here’s our base thesis as we articulated it in our 2017 year-end letter:

Technology:
While we remain constructive on tech given the global macroeconomic setup and the current pace of innovation in both products and services, we’d be surprised to see the sector maintain its lead (relative to other sectors) during 2018, for the following reasons:

1. Foreign-denominated revenue: U.S. tech companies, as a group, earn the majority of their revenue outside the U.S.. Therefore, should the prospects for economic growth and higher interest rates in the U.S. result in a stronger dollar going forward, foreign denominated earnings will take a hit when translated in U.S. dollar terms.

2. In a rising dollar environment, U.S. goods are more expensive to foreign buyers. However, we don’t (at this juncture) see this as being a major impediment to international technology sales (plus, a higher dollar is beneficial when we consider foreign-made inputs/components as well as foreign labor). That said, the trading community can be very sensitive to dollar-related dynamics, and we believe it may be especially so heading into 2018.

3. Given the sector’s outsized returns in 2017, we think that it’ll take outsized hits (relative to other sectors) when volatility visits the market, and profits are taken, in 2018.

4. Tax Reform: The tech sector stands to gain the least from the corporate rate reduction (4.5% boost to earnings) among the major sectors. 

5. Threat of U.S. protectionism: Tech underperformed other cyclical sectors measurably between last year’s election and the beginning of this year. Our view is that — along with the at-the-time appreciating dollar — the poor relative results stemmed largely from traders reacting to the prospects for a negative impact on the most internationally-centric U.S. companies, should rhetoric become reality. After the inauguration, however, it appeared as though the more aggressive of the Trump campaign’s protectionist propositions would not come to fruition, which remains the case for now. Any new trade barriers erected at this juncture could prove to be significantly negative for the sector, in our view.

Again, we’re not bearish on the tech sector (in fact, we believe there are some very compelling individual stories), we’re simply assessing its prospects for 2018 relative to other opportunities, and for now believe them to be a bit less compelling compared to a year ago.

Seven and a half months after issuing the above statement we see no reason to amend our thesis. In fact —  while, again, we’re not presently bearish on technology — recent action suggests that we may finally be seeing the sea change we anticipated coming into the year.


Here’s a one-month chart of our top 4 sector targets: click to enlarge…