Positive outlook for tech sector in '06

Published February 4, 2006
Business Times
Semiconductor and Internet are likely to be the best-performing areas this year
By STUART O'GORMAN and GEOFF PATON
Looking high: There is potential for further growth in 2006 in the Internet sector, which is expected to perform particularly well this year
WE BELIEVE the outlook for the technology sector in 2006 is positive. In our opinion, a number of factors will drive the sector over the coming months, notably a potentially benign macro-economic environment, emerging market demand, and compelling product cycles. We expect the best-performing areas to be semiconductors and the Internet, while increasing competition may cause the telecommunications equipment space to lag.

The global economy is performing well. Growth in the United States and emerging markets is strong, while inflation in most countries and long-term interest rates are low.
IT spending
The global economy is performing well. Growth in the United States and emerging markets is strong, while inflation in most countries and long-term interest rates are low.

We believe that this healthy macro-economic backdrop should encourage corporate information technology (IT) spending to return to historical norms.

However, we are aware of the major structural imbalances that continue to worsen in the global economy and present the greatest risk to our positive outlook for the technology sector and equity marketing in general.

In 2006, we view product cycles as the key driver of increased IT spending, and we would highlight Vista, Microsoft's new operating system, 3G handsets, flat-screen TVs, Fibre to the Home telecom deployments and the Xbox360/PS3 gaming systems as some of the more significant ones. In our view, the success of Vista, in particular, will be central to the performance of the sector as it has the potential to stimulate PC hardware and software upgrades.

One area that we expect to perform particularly well in 2006 is the Internet sector. Internet stocks have continued their disruptive disintermediation of old economy business models at a rapid pace, particularly within advertising. We feel there is potential for further growth in the industry and have a significant position in our technology portfolios, including holdings of Google and NHN of South Korea
The semiconductor and semiconductor production equipment sector ended 2005 strongly, and we expect more positive trends to continue into 2006. We increased our position in the sector considerably on weakness in November, and we are comfortable maintaining this position thanks to low inventories and strong order expectations.

Off-shoring remains a key theme in the portfolio and we have significant exposure to the IT services sector as a result. We believe that the movement of skilled labour to lower-cost geographies like India and China is a multi-year trend and that we are only in the embryonic stages. Having worked hard to gain the acceptance of Western businesses, locally-based firms are now best positioned to benefit from the development, as are global majors with a credible off-shoring strategy.


Potentially weak area

We feel communications equipment is an area of potential weakness in 2006. However, while we are concerned about capital spending trends on legacy wireline and wireless networks, we do believe that a number of investment opportunities are emerging as operators finally move towards next-generation networks. Our preferred plays here are in the optical and routing spaces.

To summarise, provided that the macro-economic environment remains supportive, we expect the convergence of cheap relative valuations, increasing capital expenditure, compelling product cycles, and low inventories to provide a significant tail wind for the technology sector in 2006.

The writers are co-heads, Henderson Technology Team, Henderson Global Investors (Singapore)