The S&P 500 index gained 21.83% in 2017 (including dividends), with most of the underlying sectors enjoying double digit gains, except Energy (-1.01%) and Telecom (-1.25%). Yet as the next chart shows, the Technology sector had out-sized gains that dwarfed everyone else, rising 38.83% over the year. The sector accounted for almost 37 percent of the S&P 500’s 2017 gain despite making up just over 20 percent of the broad index.
S&P 500 and 11 GICS sector performance in 2017. Source: S&P Dow Jones Indices
Technology had its best year since 2009, when it gained 61.72%, though this was after falling -43.14% in 2008. 2017 was even better than 2013, when the sector rose 28.43% (versus 32.39% for the S&P 500).
Five tech companies – Apple (+48.24%), Microsoft (+40.22%), Google (+35.58% class C shares and +32.93% class A shares), Facebook (+53.38%), Amazon (+55.96%) – accounted for just over 5 percentage points of the S&P 500’s 21.83% gain, i.e. close to a quarter of the gain even though they made up just about 11 percent of the index at the beginning of 2017.
Some of it could be put down simply to earnings growth. For 2017, the Technology sector reported the third highest earnings growth (14.6% year-over-year) of all 11 sectors versus 9.6% for the S&P 500. Though we do note that the correlation between equity performance and earnings growth is not straightforward – the Energy sector fell despite year-over-year earnings growth of 274.6%.
With the benefit of hindsight it may seem obvious that Technology was the sector to be in throughout 2017, with juggernauts like Apple, Google, Facebook and Amazon extending their dominance over not just the tech industry, but even retail, rolling over competitors big and small – Macy’s, Sears, J.C. Penney and other retailers shut down about 9,000 stores, and 12,000 more are expected to close in 2018, far beyond what you see during recessions. In fact, the U.S. economy grew at a faster clip, with GDP growth closer to 2.5 percent as opposed to recent trend levels of 2 percent. Technology would be expected to out-perform in an environment where aggregate demand is rising.
However, this was not as evident at the beginning of 2017. The S&P 500 rose almost 5% between election day and the end of 2016, but Technology under-performed with a 1.23% return over that period. The incoming Trump administration’s agenda, including tax reform, changes to the existing trade regime (which benefits tech supply chains) and immigration policies were expected to take their toll on the sector. Nevertheless, most of the changes did not materialize and even tax reform is not expected to significantly change the way technology companies do business.
The US was not the only country to see stronger growth in 2017. Developed and emerging economies across the world saw economic growth and strong equity market performance. Interestingly, the three sectors with highest international exposures – Energy (42%), Materials (47%) and Technology (60%) – showed the highest earnings and revenue growth in 2017.
Tech out-performed even outside the US
The technology sector shined even in Europe, which is a region more closely associated with heavyweight industrial companies that would be expected to out-perform amid a rebounding economy. The MSCI EMU Technology Sector Index (net, USD) gained 36.87% versus 28.06% for the MSCI EMU Index (net, USD). Though as the next chart illustrates, the out-performance was not quite as significant as in the US, and 2017 returns for the Industrial sector are not too far behind.
MSCI EMU and MSCI EMU sector performance (net in USD terms). Source: MSCI
Unlike the S&P 500, Technology makes up only a small portion of the MSCI EMU index* (about 6 percent) and so the sector accounted for under 10 percent of the overall index’s gains for 2017. Industrials (14 percent weight) and Financials (21 percent weight) were responsible for almost 40 percent of the MSCI EMU Index’s 2017 return.
Another note of interest is that Europe’s Utility sector was the second best performer in 2017, though it makes up just about 3% of the broad index. This is despite a regulatory push toward low-carbon energy, liberalization of Europe’s utility markets (so customers can shop around and switch) and new technology, all of which have sent customers fleeing from established utility companies. The result is a wave of new mergers across Europe’s utility industry, as traditional players look to move away from centralized power generation toward renewable sources that are less expensive. New competitors already offer cheaper renewable energy sources, better customer service and smart systems that allow consumers to keep a close eye on their consumption – which also bolsters the technology story.
The biggest effect of Technology sector out-performance can been seen in Emerging Market returns. The MSCI Emerging Market index (net, USD) gained 37.28% in 2017, surpassing developed market counterparts by a significant margin. Yet, as the following chart shows, almost all the out-performance can be attributed to a whopping 60.53% return for the Technology sector (MSCI EM Technology Sector).
MSCI Emerging Markets (EM) and MSCI EM sector performance (net in USD terms). Source: MSCI
Technology makes up a significant portion of the MSCI EM index (close to 24 percent*) and so the sector alone accounted for close to 40 percent of the broad EM index’s 2017 gain. Real Estate saw the second best gains (of 49.44%) but this sector comprises less than 3 percent of the EM index.
The technology story is apparent even when you look at equity performance across countries. Among individual countries with significant market capitalization, the top two performers in 2017 were China and South Korea, with returns of 54.07% and 47.30% (MSCI Index, net, USD), respectively. The Technology sector makes up 41.1% of the MSCI China Index and 37.11% of the MSCI South Korea Index*.
What is intriguing is that China and South Korea are, along with Japan, closest to North Korea in terms of proximity, which tells us that global investors are not too concerned with the ramifications of North Korea’s missile program. Instead, economic growth across the world lit up all the green signals for investors to take risk-on positions, with the Technology sector being a huge beneficiary – especially technology companies in Asia that are feeding off rising domestic demand and form critical parts of the global supply chain for the Apples and Amazons of the world.
It will be interesting to see if this continues in 2018, especially if the global economy continues along 2017’s upswing.
* Sector weights for MSCI EMU and MSCI EM index were obtained from sector weights for their corresponding ETFs (EZU and EEM, respectively). Sector weights for MSCI China and MSCI South Korea index were obtained from sector weights for their corresponding ETFs (MCHI and EWY, respectively).
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