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Will Tech ETFs Continue Their Rally in Q3 Earnings?

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After a lackluster first half of 2016, the technology sector is on a tear in the third quarter reporting cycle on improving fundamentals, a string of solid earnings reports, and investors’ drive for cheaper valuation. This trend is likely to continue through this earnings season given the solid earnings reports from Netflix NFLX and International Business Machines IBM after the closing bell on October 17.

While IBM earnings beat failed to cheer the market erasing some of the gains for the sector, Netflix sparked a rally in the broad sector posting its best day since April 2013 by rising nearly 20% following the earnings release (read: Buy These ETFs on Netflix Blowout Q3 Earnings).

As a result, the tech heavy Nasdaq Composite Index rose 0.8% on October 18. And tech ETFs saw smooth trading, with the four popular funds – Select Sector SPDR Technology ETF XLK, Vanguard Information Technology ETF VGT,iShares Dow Jones US Technology ETF IYW andMSCI Information Technology Index ETF FTEC – gaining at least 0.5% each.

Investors should note that these funds have the largest allocations to the four tech giants – Apple AAPL, Microsoft MSFT, Alphabet GOOGL and Facebook (FB - Free Report) – that dominate the fund’s portfolio. IYW has the largest concentration in these firms with a combined share of 43.1%, followed by 38.6% for VGT, 36.4% for XLK and 34.4% for FTEC.

Let’s dig deeper into the earnings picture of these companies that would drive the performance of the above-mentioned funds in the coming days (see: all the Technology ETFs here):

Inside Our Surprise Prediction

Apple is slated to release earnings after market close on October 25. The stock has seen positive earnings estimate revision of four cents over the past 90 days for the yet-to-be-reported quarter. It has a Zacks Rank #2 (Buy) and an Earnings ESP of +1.21%, indicating higher chances of beating estimates this quarter. Further, the iPhone maker delivered positive earnings surprises in three of the last four quarters, with an average beat of 1.03%. The stock has a VGM Style Score of B (read: Is Samsung's Pain Apple's Gain? ETFs in Focus).

Microsoft has a Zacks Rank #3 (Hold) and an Earnings ESP of 0.00%, which makes surprise prediction difficult. It delivered positive earnings surprises in three of the last four quarters, with an average beat of 11.49%. The Zacks Consensus Estimate for third-quarter 2016 remained unchanged at 68 cents over the past three months. The stock has a VGM Style Score of C. The company is expected to report after the closing bell on October 20.

Alphabet has a Zacks Rank #2 and an Earnings ESP of 0.00%, which makes surprise prediction difficult. However, the earnings surprise track over the past four quarters is good with an average beat of 1.66%. Google also witnessed a positive earnings estimate revision of 19 cents over the past 90 days for the yet-to-be-reported quarter. The stock has a VGM Style Score of C. The company will report after the closing bell on October 27.

Facebook is expected to release its earnings report on November 2 after market close. It has a Zacks Rank #4 (Sell) with an Earnings ESP of 0.00%. According to the our surprise prediction methodology, a Zacks Rank #1 (Strong Buy), #2 or #3 when combined with a positive Earnings ESP has chances of an earnings beat, while a Zacks Rank #4 or #5 (Sell rated) are best avoided. Facebook delivered positive earnings surprises the last four quarters, with an average beat of 18.25% and saw positive earnings estimates revision of eight cents over the past three months for the to-be-reported quarter. The stock has a VGM Style Score of B.

Summing Up

Overall, the tech sector is expected to post an earnings decline of 0.4% in the third quarter compared with 1% growth in the second quarter (read: 4 Best ETFs & Stocks to Tap the Tech Boom).

Though the modest negative earnings growth outlook might hit the sector ETFs, surprises might be in the cards given the most conservative estimates. This is especially true as some hopes of earnings surprises have been building up lately. As per the  Earnings Trends report, the S&P 500 tech companies that have reported so far have come up with earnings growth of 4.2% and the beat ratio is 84.6% (read: 5 Reasons Why the Tech ETF Boom is Here to Stay).

If the trend of earnings beat continues, the funds will actually get a boost in the coming days. In particular, XLK, IYW and VGT have a Zacks ETF Rank of 1 while FTEC has a Zacks ETF Rank of 3.

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