Saturday, September 24, 2011

Tech’s Outperformance Driven by the Big Boys

Apples and Googles of the world are beating headwinds

Quick — what’s the one stock you feel comfortable owning right now? If you said Apple(NASDAQ:AAPL), you’re not alone. Among large-cap stocks, there aren’t many that offer the combination of Apple’s massive balance sheet, strong organic growth and promise of future catalysts in the form of hot new products in the pipeline. It’s no surprise, then, that the stock has outperformed both the S&P 500 and the broader tech sector since the market started going south at the beginning of May.
While Apple garners all the headlines, it isn’t the only tech stock to outshine its large-cap peers in recent months. A look at the numbers shows meaningful outperformance for seven of the eight largest tech stocks since the April 29 top:
Looking at this, one would think that the tech sector as a whole has been a safe haven through the market downturn. In fact, that’s been anything but the case. Beneath the $50 billion market-cap cut-off, the numbers are not nearly as positive. In fact, 14 out of the next 20 largest U.S.-domiciled tech stocks have failed to keep up with the S&P 500 since the market started to roll over. Granted, some of these companies are stock-specific stories that would have underperformed in any market.Hewlett-Packard (NYSE:HPQ), Research In Motion (NASDAQ:RIMM) and Yahoo(NASDAQ:YHOO) are names that jump out from the list. Still, the table below shows that it isn’t necessarily accurate to talk about “technology’s outperformance.”
So what’s driving the outperformance of the largest tech stocks? The simple answer is, of course, fundamentals. In terms of their earnings, balance sheets and market positions, these companies are much better equipped to deal with macroeconomic headwinds than most stocks in the financial or cyclical sectors. How long stocks like Apple, Amazon (NASDAQ:AMZN), and Google(NASDAQ:GOOG) remain immune to a slowing economy is up for debate, but for now it has paid handsomely to stick with what’s working.
There’s more to this story than just fundamentals, however. If an equity-only fund manager needs a hiding place, he or she doesn’t have the option to buy gold or Treasuries. The logical safe haven is large-cap, cash-rich companies with stories that have a demonstrated ability to keep growing despite the slow economy. More to the point, there’s no “career risk” to holding Apple in your portfolio right now. In short, these stocks have become a safe haven for dedicated-equity managers that have nowhere else to hide.
The result is that the large-cap tech trade has become very crowded. In the short term, that doesn’t matter — as long as the markets remain weak, this trade can keep working. But once the market stabilizes and managers move back to the “risk-on” trade, these outperforming stocks likely will represent a source of funds.
The bottom line: Ride this wave of remarkable outperformance for the largest tech stocks as far as it will go. But recognize it for what it is, and be ready to look elsewhere for opportunities once the VIX makes it back to the mid-20s.

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