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Two Funds for Tech's Big Spending Season

12/08/2010 1:00 pm EST

Focus: FUNDS

Jim Lowell

Senior Partner & Chief Investment Strategist, Adviser Investments

Jim Lowell, editor of Fidelity Investor, suggests two funds to capitalize on the sector’s window of opportunity.  

We’ve all profited from the technology stock surge that has been the driving force of the post-recession rally. In spite of all the hand-wringing the recovery trend was predictable, in terms of businesses spending on IT upgrades in order to enhance the productivity of their existing workforce before any thoughts of new hires. Here and now, there’s also a seasonal factor that has historically helped technology plug into profits.

Tech’s twin macro trends remain in place and in play: Technology often moves as economies rebound and companies that haven’t spent for a couple of years as the economy faltered are now back in buying mode for functionality, upgrades of legacy systems, and competitive reasons.

Point of fact, the revised third-quarter gross domestic product reflects that business spending on IT was up 15%-plus from last year’s third quarter. Business spending is more than the tip of tech’s iceberg; but consumer spending on IT has become the lingua franca of and for our daily discourse. The consumer trend held up even when business spending on IT failed to do so in the whirlwinds of late 2008.

With remarkable gains already in the tech tank, it’s less an issue of the long-term mileage we can get out of the tech stocks, and more a question of whether or not the high-octane seasonality surge for technology stocks, the four-month period between November and February when tech stocks traditionally post some of their best market-beating numbers, is on track this year.

“The ‘Budget Flush”

Why is technology historically hot during these coolest of months? A number of factors can explain this outperformance.

The first has to do with fourth-quarter spending by corporations. Information technology managers tend to hold back some of the money in their budgets during the year in case of a late emergency or other pressing need. As the calendar draws closer and closer to year-end, this unspent money needs to be used. Why? Because the tech managers know that if they have something left over they’re likely to see a reduction in their budgets next year, and they don’t want that. So rather than see their resources cut they spend freely in the year’s final months.

That spending also has tax implications for companies that want to cut what they owe the government. Whatever the rationale, this spending surge, sometimes called a “budget flush,” is often noticed in the markets. And the tech stocks that are expected to benefit from this seasonal year-end spending begin rising on expectations of increased earnings in the coming year.

With the global economy expanding, now more than ever, there is a need for upgraded or replacement technology. The juggernaut is not going to stop.

Refreshed and Ready to Spend

A second and wholly separate factor is Europe. European purchasers account for a significant percentage of US technology orders, and during the fourth quarter they do a lot of buying. This happens year after year because of the longer summer vacations European companies give their workers, which cause summertime orders to slack off.

When workers return, orders begin rising in the fall and through the winter, often hitting a peak in the last few months of the year. Add in the fact that the dollar’s weakness means US technology is globally cheaper today than it was a year ago.

Let’s add another factor: discounts. Hardware companies, beginning to retool for new product launches, start offering discounts on existing inventory to speed sales. These discounts allow corporate purchasers looking for proven technology to buy the cheap, well-tested products still sitting on manufacturers’ shelves.

The net effect is that technology companies begin to see increased demand, and tech stocks rally in advance of earnings news. The seasonal pattern for technology draws to a close after the start of the new year, when technology companies restock their inventories and a new purchasing cycle commences.

Over the last 20 years, some of Fidelity's most technology-heavy funds have handily outperformed the market between November and February.

Should you want to both own great funds and try to make a bet on a good tech season, my favorite choices among open funds with heavy tech holdings and managers who know how to use them would be Fidelity Contrafund (FCNTX) and Fidelity Growth Discovery (FDSVX).

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