Going forward, I am positive about the information technology (IT) sector. With improving business confidence, I believe that capital expenditure (Capex) spending of U.S. companies, which has been subdued so far, will grow faster, creating a stronger demand for sectors such as semiconductors, cloud computing, and e-commerce.
In the month of August, I made three changes to the Long Only Sector Rotation portfolio. I increased exposure to the 3D printer producer, Stratasys (SSYS). In the last three months, 3D stocks have had a disappointing performance as the stocks were oversold by some short-sighted investors in my opinion. We find the growth story in the 3D industry very compelling, and continue to expect outperformance in the coming months.
We also bought the stock in the ratings agency Moody’s (MCO) as our top-down stock selection model puts this stock in the top 25th percentile. MCO provides credit ratings, economics research, data, and analytical tools globally. The company has an excellent return on equity and increasing profit margins.
Moody’s revenue and income growth is above the sector average, and the earnings surprise trend has been increasingly positive in the last three quarters. Furthermore, I believe that the ECB’s attempt to revive the asset-backed security market in Europe could lead to more securitizations and higher demand for the services of rating agencies.
I also added Flextronics (FLEX) to the portfolio. I’m bullish on technology stocks and FLEX falls into the top 20th percentile of my stock universe. FLEX is a provider of advanced design, manufacturing and services to original equipment manufacturers of a range of electronic products, which includes its mobile devices business, including smart phones, and consumer electronics, including game consoles, high-volume computing business, including notebooks and printers.
The company’s P/E ratio is below the industry average. Moreover, FLEX has a strong revenue and earnings growth, a high return on equity and its earnings per share has beaten the market expectations in the last four quarters. Furthermore, this company is engaged in buy-back programs. In my opinion, this program may benefit the stock price in the coming months.
Market and economic overview
The S&P 500 Index and Nasdaq Composite indices closed the month of August with gains of 3.77 percent and 4.8 percent, respectively, compared to the end of last month. Despite the intense geopolitical risks in the Middle East and Ukraine, positive economic news from the US and better-than-expected American company earnings seem to have outweighed the negative investor sentiment.
According to the latest estimate by the Bureau of Economic Analysis, GDP grew 4.2% in the second quarter of 2014, revised upwards from the previous estimate of 4%. The revision was due to a larger-than-expected increase in nonresidential fixed investment and exports. The price index for GDP increased 1.9%, which is in line with the Fed’s target rate of 2 percent inflation. These revisions have not dramatically changed the economic picture.
The Fed remains cautious about how quickly it will raise rates. Although, the number of jobless claims has been steadily declining, the US labor market is not out of the woods yet, as indicated by stagnant wage growth. On the business side, there were some positive developments: the ISM manufacturing index for July rose to 57.1, healthiest number since 2011. Furthermore, about 70 percent of earnings results from S&P 500 companies beat the expectations of analysts, indicating that the US equity market fundamentals are still improving.
There has been also some positive news from the housing market, as home purchase contracts increased in July, rebounding from a drop in June. According to the National Association of Realtors’ report, monthly “pending home sales” index rose 3.3 percent in July over June.
Geopolitical risks
Geopolitical risks continue to be cause for concern as Ukraine accuses Russian troops of invading the country. Economic sanctions are expected to affect Russia and European economies adversely. Although, there has not been a significant upward movement in oil and gas prices due to the strong supply from Iraq and the production in the US, geopolitical risks related to Ukraine are likely to continue causing volatility in the markets.
If the conflict in Ukraine worsens, European Union’s tougher sanctions on Russia may be extended to its energy and finance industries. Unlike Europe, which has both trade and energy ties with Russia, the direct impact of the Russian conflict on the US companies is limited. However, growing tensions in Ukraine and Iraq can cause occasional sell-offs in the US equity market in coming months.
After the very low reading of inflation for August (0.3 percent), the European Central Bank is expected to expand its monetary stimulus measures as the GDP growth in the major economies of the Eurozone fell below expectations. The worrying part is, even Germany’s economy, which is supposed to be rock-solid, contracted 0.2% in the second quarter of 2014. Expectations about a monetary stimulus in the Eurozone, possibly broad-based asset purchases led to a depreciation of Euro against the US Dollar. In the coming months, appreciation of the dollar may have some negative effect on the export-oriented US companies.
DISCLAIMER: The investments discussed are held in client accounts as of August 31, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
