Strong Technology Performance Looming

 | Jul 02, 2013 | 11:00 AM EDT
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This week we are looking for sectors and stocks that should outperform in the second half of the year. On Monday, I highlighted a couple of small banks which should see net interest margin expand on the back of the higher rates we have seen in the market recently.

The last time we had a substantial rise in interest rates without a corresponding increase in inflation was in 1994. During that year in the market, technology outperformed the overall market while utilities turned out to be one of the lagging sectors.

We have already seen a reversal of the strong performance utilities had during the first four months of the year over the past two months. I think in the second half of the year we will see the second part of this thesis play out with the technology sector outperforming the overall market. We are already seeing this divergence over the past two months. After being a laggard for the first four months of 2013, the tech sector is strongly outperforming utilities over the past eight weeks (See Chart).


I believe this outperformance will continue in the last six months of the year, not only against defensive sectors like utilities but also the overall market. The sector is cheaper than the overall market and also provides better overall growth opportunities. Tech should also benefit as investors shift from a value and income bent to a growth mode. The easiest way to take advantage of the projected strong performance within tech is to overweight the sector within one's portfolio using an ETF like the Technology Select Sector SPDR (XLK). For investors looking for individual names in the sector, a couple of selections are highlighted below.

For investors looking for value & income to go with their growth, Microsoft (MSFT) makes a lot of sense here. It has a fortress AAA rated balance sheet with tens of billions of dollars in net cash and marketable securities on the books. It yields 2.7% and is likely to announce another dividend hike by the end of the year. It is not expensive at just over 11x forward earnings (9x accounting for cash). The company is also projected to grow revenues at a 7% pace over the coming year.

Microsoft also is making good progress moving to the "cloud". It has two offerings (Microsoft 365 & Azure) in this space that are running at better than a $1B annual sales pace. The new Xbox console launches later in the year in time for the important holiday season. It also recently announced a strategic partnership to create a "Windows Store" at Best Buy (BBY) and is expanding a partnership with Oracle (ORCL) to enhance its web services offering.

For investors who want to move out on risk curve, storage memory platform provider Fusion-io (FIO) looks interesting here. The company is growing revenues at a 20% pace this year and the consensus analyst estimate is for that growth to accelerate to 30% on new product rollouts in FY2014. In addition, approximately 35% of its market capitalization is in net cash.

In addition, there has been significant speculation that FIO could be a logical buyout candidate after the acquisition of STEC, Inc. (STEC) by Western Digital (WDC) recently. Mizuho came out with a note stating FIO should receive at least a third more than their current stock price of under $15 a share in a buyout last week.

Subtracting cash, FIO has a market cap of just over $1billion and would be a bite- sized acquisition for a larger player. Needham also initiated the shares as a "Buy" two weeks ago, stating the sentiment on the stock has reached a trough and put a price target of $20 on FIO.

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volatility is quite low here, and we could see some downsides here in the short term. ...



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