McCall’s Call: Moving Beyond Chip ETFs


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 But even that may be a bit outdated.

Matthew D. McCall 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 briskly.

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 percent.

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 semiconductor stocks.

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 computing sector.

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 SMH.

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 future.

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 ETFs.

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Copyright ® 2011 IndexUniverse LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , ETFs

Referenced Stocks: IGV , SMH , XLK



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