SAN FRANCISCO (Reuters) - Technology companies have been a driving force behind the U.S. stock market's recent record rally, and despite mounting evidence of stretched valuations the sector remains a top pick for investors expecting a wave of capital expenditures by U.S. corporations.
Corporate tax cuts and reduced regulations planned by President Donald Trump will give companies reason to spend more on cloud computing, factory automation and smart connectivity that will directly benefit Silicon Valley, many on Wall Street believe.
"The tax cuts are going to promote business investment across all industries, and the business investment is largely going to be in technology," said Doug Cote, chief market strategist at Voya Investment Management in New York.
Strong performances from big names including Apple Inc. and Facebook Inc have helped make technology the strongest S&P 500 sector so far this year, surging 10 percent compared to the broader index's 6 percent rise.
In the past month, investors have poured $325 million into to the U.S.-listed Technology Select Sector SPDR Fund, according to ETF.com, which tracks fund flows.
"We may be due for a little bit of a pullback, but we're still buyers on weakness because we like the longer-term outlook over the next two to three years," said Terry Sandven, chief equity strategist at U.S. Bank Wealth Management.
The proliferation of smart, connected devices in homes, factories and stores is leading to the collection unprecedented amounts of data and creating demand for more computing power to analyze it.
Spending on cloud computing will grow by 21.5 percent a year through 2020, almost seven times as fast as overall IT spending, according to a recent estimate by market research firm IDC.
PRICIEST OF THE PRICEY
Improved employment and consumer confidence have also been behind investors' optimism about tech, helping offset concerns about lofty valuations.
After an eight-year U.S. stock market rally, nearly all sectors are trading at earnings multiples above their long-term average, but none more so than technology, according to Thomson Reuters Datastream. The tech sector's strong performance has left it trading at 17.9 times expected earnings, compared to its 10-year average of 14.5 times expected earnings.
The S&P tech sector's price-to-earnings multiple has been above its own long-term average for about a year, and during that time the sector has surged about 28 percent.
Tech bulls believe earnings momentum is growing for the sector. S&P 500 tech earnings expanded 12.3 percent in the fourth quarter, more than any other sector, according to Thomson Reuters data. Analysts on average expect 13.6 percent growth for the March quarter.
Recent upbeat quarterly reports and commentary from Broadcom Ltd, Skyworks Solutions Inc and Applied Materials Inc suggest semiconductors are poised for strong growth, said Wedbush trader Joel Kulina.
Micron Technology Inc. jumped 3.5 percent on Friday after raising its 2017 forecast the day before, helped by healthy demand for its memory chips.
"I can't remember a time when we've seen this much excitement," Kulina said. "Semiconductors aren't as cyclical as they used to be, where quarters were driven by PC demand. Now it's automotive, it's data center, industrial automation."
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