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Forget Big Tech, Focus on These ETFs Instead

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Global growth worries, a strong dollar, lesser expectations of higher interest rates, and a spate of disappointing earnings reports from big players have dampened the technology sector this year. In fact, Q1 earnings of the S&P 500 tech sector has been the worst in many quarters with earnings and revenue growth as well as beat ratios tracking below the 4-quarter and 12-quarter averages, as per the latest Zacks Earnings report.

However, with a sooner-than-expected interest rate hike speculation back on the table and regained momentum in the U.S. economy, the sector showed impressive rebound over the past five trading days. Notably, the S&P 500 Information Technology Sector Index is up over 4% versus the gain of 2.4% for the S&P 500 Index (read: Rate Hikes Back in Play: ETFs to Profit).

Behind the Surge

The impressive gain came on the back of the recent spate of upbeat data that suggests the U.S. economy is back on track after a slowdown in the first quarter. Additionally, international fundamentals have also improved with stabilization in China and a jump in oil prices. With this, investors regained their lost confidence in the economy. Economically sensitive growth sectors like technology that typically perform well in a maturing economic cycle also got a solid boost.

As the world is becoming increasingly digital, demand for novel and advanced technologies such as cloud computing, big data, smartphones, high-speed fiber networks and the Internet of Things is growing by leaps and bounds. These are creating opportunities for the tech companies. Further, most of the tech companies have huge cash piles on their balance sheets and are in a position to increase payouts to their shareholders. These companies will not face any financing problem in a rising interest rate environment due to their cash reserves. Notably, technology has been the highest dividend-paying sector in the S&P 500.  

Moreover, Apple (AAPL - Free Report) , which was punished since it reported the worst fiscal second-quarter results and touched a low of $89.47 on May 12, surged 11% over the past week to trade above $100 per share. Notably, Apple accounts for 19.4% of the total market capitalization of the entire technology sector in the S&P 500 index (read: Buffett Takes a Bite of Apple: Should You Taste Its ETFs?).

Given the recovering trends, technology ETFs are no doubt surging but small caps have emerged as the real winners when compared to their large cap counterparts. This is because a strong dollar, geopolitics and the threats of global slowdown will continue to hurt worldwide demand and information technology spending, thereby weighing on revenues and profitability of the big tech companies.

As a result, we have highlighted four broad tech ETFs that have less exposure to the big players and are expected to outperform in the coming months (see: all the Technology ETFs here).

First Trust Technology AlphaDEX Fund (FXL - Free Report)

This fund follows an AlphaDEX methodology by tracking the StrataQuant Technology Index and ranks stocks in the space by various growth and value factors, eliminating the bottom-ranked 25% of the stocks. The approach results in a basket of 82 stocks that are well spread out across each security with none holding more than 2.46% of assets. Within the broad sector, semiconductors and software take the top two spots at 22.9% and 19.6%, respectively, while electronic equipment, IT Services and communications equipment round off the top five. FXL is rich in AUM of $485.9 million and trades in solid volume of around 231,000 shares a day. It charges 63 bps in annual fees and climbed about 6% over the past five trading sessions. The product has a Zacks Rank of 1 or ‘Strong Buy’ rating with a High risk outlook (read: Time to Invest in Tech ETFs?).

PowerShares S&P SmallCap Information Technology Portfolio (PSCT - Free Report)

This fund tracks the S&P SmallCap 600 Capped Information Technology Index. It has managed $368.8 million in its asset base and trades in light average daily volume of about 36,000 shares. The ETF charges 29 bps in fees per year from investors. Holding 98 securities in its basket, the product is well spread across securities with none holding more than 3.38% share. From an industry look, about one-fourth of the portfolio is allocated toward electronic equipment, followed by semiconductors (21.8%) and software (18.4%). The product gained 6.2% in the same timeframe and has a Zacks ETF Rank of 2 or ‘Buy’ rating with a High risk outlook.

PowerShares DWA Technology Momentum Portfolio (PTF - Free Report)

This fund follows the Dorsey Wright Technology Technical Leaders Index, and provides exposure to companies that are showing relative strength (momentum). Holding 33 stocks in the basket, it is well diversified with each holding less than 5.7% share. The product is illiquid and unpopular with AUM of $162.6 million and average daily volume of 49,000 shares. The fund was up 5.5% in the same timeframe and has a Zacks ETF Rank of 3 or ‘Hold’ rating with a High risk outlook.

Guggenheim S&P Equal Weight Technology ETF

This ETF offers equal weight exposure to 68 tech firms by tracking the S&P 500 Equal Weight Index Information Technology. Each firms accounts for less than 2.1% share in the basket. IT services, semiconductor and software are the top three sectors with double-digit exposure each. RYT has amassed $677 million in its asset base while trades in moderate volume of around 95,000 shares. It charges 40 bps in fees per year and gained 4.7% over the past five days. The product has a Zacks Rank of 1 with a Medium risk outlook (read: 4 Sector ETFs Jump to Top Ranks as Q1 Earnings Hit).


Bottom Line

Investors should note that these funds clearly outperformed the ultra-popular tech fund (XLK - Free Report) over the past week and has the potential to continue doing so in the near future. This is especially true as these funds avoid higher exposure to the big names, which are vulnerable to economic uncertainty.

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