In a few more days, the current bull market will officially reach its second birthday. Since March 2009, the stock market has posted an amazing gain, roughly doubling from its lows. Of course, the question from here is: Has the market run out of steam, or are there still more gains to be had?
It's true that the market is not as cheap as it was two years ago. Economist Robert Shiller introduced the concept of the Cyclically Adjusted Price Earnings Ratio, or CAPE, which divides market prices by a 10-year average of earnings so as to smooth out the effects of business cycles. According to this measure, the P/E of today's market is 23.5. This compares with a figure of 13.3 in March 2009 and a 130-year historical average of 16.4. Now this is just one measure of valuation, but it does suggest that the low-hanging fruit has already been plucked, so to speak. And while broad-market equity investors should do just fine over the long run, stock pickers may want to think about delving further into more undervalued sectors.
Tech is king
I think there are several sectors that should do well in 2011, including financials and health care, but the one I'm most excited about is information technology. After tightening their belts and cutting back during the last recession, U.S. companies were sitting on a cash hoard of $1.93 trillion as of December 2010, their largest such cushion in five decades. And while I expect companies will continue to sit on much of that cash until business conditions show meaningful and sustained signs of improvement, firms can only put off upgrading their systems and technologies for so long.
In fact, market research firm IDC expects tech spending in 2011 to nearly double from 2010 levels, from a roughly 3% gain last year to a 5.7% increase this year. And once economic growth begins to pick up some more and the employment picture begins to improve, which I think could happen as early as this spring, spending in this sector could really take off.
Not to mention that many companies in the IT sector are selling at extremely reasonable valuations nowadays. Former growth stalwarts like Microsoft
And if you look at overall tech valuations in comparison to the general level of activity in the sector, there's even more of a case to be made for tech being a bargain. In January 2011, the Federal Reserve Bank of San Francisco Tech Pulse Index -- which is a measure of employment, investment, production, shipments, and consumption in the tech sector -- came in at 114.8, its highest level since the tech bust and pretty close to its all-time high of 121.3, reached back in October 2000 at the height of the tech bubble.
But valuations are a far different matter. While the P/E ratio of the S&P 500 Information Technology Index peaked close to 70 back in 2000, it currently clocks in at less than 20. That's a huge gap that points toward a potential run-up in tech stocks that won't end with the bursting of a bubble this time around.
Although information technology put in a strong showing in 2009, it was beaten back down to the bottom of the pack last year. If we look at the performance of the iShares Dow Jones sector ETFs as proxies, technology had a bang-up year in 2009, with a 63.8% gain, as measured by the iShares Dow Jones US Technology ETF
This is actually a pretty good signal for tech to outperform this year, as sector leadership tends to vary widely from year to year, with underperforming sectors rocketing to the head of the class the following year. Even if it's not the top-performing sector in 2011, all the signs are in place for tech to put in a solid showing.
Now, if you want to get in on the action that tech has to offer as the economy recovers, there are plenty of options. There are a number of exchange-traded funds that track the tech sector that you can buy for a song, including Vanguard Information Technology ETF
Tech from the best
There are a number of top-drawer actively managed mutual funds that are leaning heavily into the information technology sector, but one of my favorites here is Fidelity Contrafund (FCNTX). This is one of Fidelity's single best offerings, and it has beaten the pants off its large-growth competition, with a 15-year annualized return of 9.6%, ahead of 96% of its peers. Longtime manager Will Danoff currently devotes 38.5% of the portfolio to the information technology sector, so there's lots of room for you to benefit.
Danoff likes top holding Apple
I think there's a lot of room for the tech sector to run in the next year or so, and the generally low valuations in this arena seem to support that idea. If you're looking for a solid sector from which to fish for some bargains, this looks like a pretty sweet spot.
Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. Amanda owns shares of Fidelity Contrafund. Microsoft and Google are Motley Fool Inside Value recommendations. Apple is a Motley Fool Stock Advisor choice. Google is a Motley Fool Rule Breakers recommendation. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool has written puts on Apple and owns shares of Microsoft, Apple, Google, and Oracle. Try any of our Foolish newsletter services free for 30 days.
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