In the age of computing and the Internet, the semiconductor
industry has become a leading indicator for the technology sector
and overall global economy. But even that may be a bit
If you were to conclude that the tech sector is flat on its back
and the economy can't be far behind because the widely followed
Philadelphia Semiconductor Index (SOX) recently hit its lowest
level since November, you just might be wrong.
That's because the chip industry is splitting-with the old
markets, such as desktop computers, lagging, and the newer
generation of products, like iPads and smart phones, still selling
Research firm Gartner expects annual sales of the overall chip
sector to increase by 6 percent annually in the next four to five
years. A large portion of that growth can be attributed to iPads
and smart phones.
So, I thought that looking at ETFs that parse the old and the
new in the world of tech might be sensible at a time when the
economic recovery appears to again be vulnerable amid sovereign
debt crises on both sides of the Atlantic.
Semis Vs. Technology
The HOLDRS Semiconductor ETF (NYSEArca:SMH), a throwback to the
heyday of the Internet bubble, is the bellwether of the adage
"where chips go, so too does the economy."
Year-to-date, SMH is down a bit less than 1 percent.
By the way, SMH isn't a bona fide ETF; it's just an
exchange-traded basket of securities that was put together many
years ago and, apart from the companies that have gone out of
business and are no longer part of SMH, its composition is frozen
in time. While still valuable, it's also become a metaphor for how
much has changed.
So, if you look at the SPDR Select Sector Technology ETF
(NYSEArca:XLK), a real broad-based ETF with more ties to the modern
world of technology, things look different. XLK's year-to-date
returns are 2.5 percent.
While XLK's and SMH's 2011 returns aren't too far apart, they
look quite different since they both reached highs earlier this
year. Since then, SMH is down 12.7 percent and XLK has fallen 4.6
SMH's sharp slide has many stock-market watchers concerned about
the rest of the technology-related sectors as well as electronics
companies and retailers selling anything with a microchip.
As I said, that may be a hasty judgment. And, behind the
divergent returns of SMH and XLK is the diversification of XLK and
the fact that only 11 percent of the ETF is invested in
The majority of XLK is allocated to computers and peripherals;
software; and IT services. The heavy weight in the ETF is Apple
(NasdaqGS:AAPL) with a 13.4 percent allocation.
Software:The New Indicator?
These days, companies cutting overhead while increasing
production means they're eliminating jobs. This is possible because
of the development of software that can do jobs only people could
do in the past.
That's why I believe software and, more specifically, the cloud
computing space, is the future of technology.
To my point, the iShares S&P GSTI Software ETF
(NYSEArca:IGV) has outperformed both the semiconductor and
technology ETFs with a gain of 5 percent in 2011. The ETF is
heavily weighted towards big names such as Microsoft (Nasdaq:MSFT)
and Oracle (Nasdaq:ORCL), but also has some exposure to the
lesser-known companies that are players in the booming cloud
Investors open to narrowing their focus to the cloud computing
sector now have an option in the world of ETFs:the First Trust ISE
Cloud Computing ETF (NYSEArca:SKYY). There is some overlap between
IGV and SKYY, but the major difference is the exclusion of the
mega-cap names in SKYY.
The benefit of cloud computing is that it allows companies to
outsource much of their information technology infrastructure,
while also enabling them to increase productivity of their
employees through more efficient access to information. It sounds
like a win-win scenario for all parties involved.
A Technology Portfolio
To sum up all these crosscurrents, XLK may be the best option
for the passive investor because it gives exposure to the large-cap
names as well as most of the sectors within the industry.
More active and risk-tolerant investors might consider picking a
couple of technology ETFs to play the boom in cloud computing,
software or even an intermediate-term bounce in semiconductors.
This strategy is more time-consuming, but the long-term payoff
could be higher.
If I had to take positions today, it would be in SKYY and
The SKYY play is a long-term bet on the emerging cloud computing
sector, and SMH is a value play, as it's lagging its peers and is
due for a rebound.
But, both positions need stop-loss orders as soon as they're
purchased, due to the potential of high volatility in the
Matthew D. McCall is editor of The ETF Bulletin and
president of Penn Financial Group LLC, a New York-based wealth
management firm specializing in investment strategies using
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