Why Tech Stocks Are Getting Pricey

This article was originally published on ETFTrends.com.

Tech stocks and the technology sector is the largest sector exposure in the S&P 500 - the group has been the best-performing sector in the U.S. for over a year. Technology's bullish ways are not, however, a free lunch as rising valuations indicate.

After surging 37% last year, technology remains a favorite among investors, despite data suggesting technology stocks are relatively expensive as they trade at elevated price-to-earnings compared to the broader S&P 500. Roughly a third of global fund managers say they are overweight tech in their portfolios, according to a recent Bank of America Merrill Lynch survey.

The PowerShares QQQ (NasdaqGM: QQQ), which tracks the tech-heavy Nasdaq-100 Index, is outpacing the S&P 500 this year, but a small number of stocks are driving QQQ's upside. FAANG stocks, or Facebook (NasdaqGS: FB), Apple (NadaqGS: AAPL), Amazon (NasdaqGS: AMZN), Netflix (NasdaqGS: NFLX) and Google (NasdaqGS: GOOG), make up about 37.2% of QQQ’s underlying portfolio.

“Tech stocks valuations are trading at an 11 percent premium to the broader market, the highest spread since 2009, according to Bank of America Merrill Lynch strategists,” reports CNBC. “The tech sector is still 4 percent below its historical average, excluding the premium it had in the tech bubble. The S&P technology sector is up 7.6 percent year to date, while the S&P 500 has risen 1.5 percent. The tech-heavy Nasdaq is up 6.7 percent so far this year.”

Technology: It's Not the Only Sector Richly Valued

The Technology Select Sector SPDR Fund (NYSEArca: XLK) is the largest tech-specific ETF. XLK includes companies from technology hardware, storage, and peripherals; software; diversified telecommunication services; communications equipment; semiconductors and semiconductor equipment; internet software and services; IT services; electronic equipment, instruments and components; and wireless telecommunication services.

“Bank of America Merrill Lynch strategists said with the decline in share prices, the valuation of S&P 500 stocks has fallen to a level last seen in late 2016. That is based on the forward price-earnings ratio, which BofA says is now 17 times, still 11 percent above its long term average,” according to CNBC.

Technology is not the only sector that is richly valued. Consumer discretionary, home to Amazon and Netflix, “is now trading at a 22 percent premium to the market, well above its historic 9 percent premium. As prices rose for discretionary stocks, earnings per share for the sector have fallen since late 2016,” reports CNBC.

For more information on the tech sector, visit our technology category.

Tom Lydon’s clients own shares of QQQ, Apple, Facebook and Microsoft.

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