TSX TrendWatch Weekly

In a recent article in the Globe & Mail, Andrew Willis introduced seven upcoming IPOs involving Canadian high-tech companies. Such IPOs have been few and far between since the tech boom came to an end at the end of the ’90s. I add some of my own commentary on this topic below.  But first, last week’s bad news.

WEEKLY REVIEW… The S&P/TSX Composite Index dropped -2.9% last week after a -2.2% decline the week before. That makes for a -3.4% drop year-to-date.

The biggest decliners over the week were  FINANCIAL SERVICES, ENERGY and INFORMATION TECHNOLOGY.

UTILITIES  and CONSUMER DISCRETIONARY are now at the top of our trend list, although all 9 of the 10 sectors took hits last week. HEALTH CARE was the exception.

The S&P/TSX Venture Index  fared about the same as the S&P/TSX Composite Index with a -2.7% drop.  All of the major US indexes took about a -4% hit, as volatility jump back into the markets. The VIX rose 53% over the past week.

Gold, silver and other commodities were also on the decline as the US dollar experienced another (temporary?) rally.

Although the past two weeks have cumulatively hit our bottom line, we’re certainly not in panic territory yet. 63% of stocks in the S&P/TSX Composite Index are still trending upward, although at a slightly more modest +0.2% per week on average.

TECHNOLOGY REVIVAL?  In the recent Andrew Willis StreetWise column (linked at the top), he lists seven Canadian companies seeking listings on either the TSX or one of the American exchanges (or both), after they complete their IPOs.  Here is the list for future reference…

• Mitel Networks… back as quite a different company than it once was, but still a telecom equipment provider
• Smart Technologies… a digital whiteboard manufacturer
• ViXS Systems… multimedia networking equipment
• Avid Life Media… web-based dating services including the very popular AshleyMadison.com adultery site
• Glassbox Television… Internet-based TV
• Radialpoint… wiring digital homes
• Vision Critical… digital marketing

No doubt we’ll see more about these companies as the IPOs unfold.

As many of you know, Canadian IT companies have had a fairly low profile in the past few years after the tech boom fizzled. At the peak I was still running a Canadian-only IT web site like this one with over 500 public listings. Today I’m hard pressed to come up with 150, and you’ve frequently heard me complain that the S&P/TSX Information Technology Index has merely 5 constituents of which Research in Motion carries the biggest weight by far.

Nonetheless, there are definitely signs that things may be picking up. PC sales have increased with the release of Windows 7, and a resurgence in Internet properties has led to returning demand for broadband infrastructure. Niche players like some of those in the list above are also gaining more attention.

As investors we also need to think about what we consider to be “tech companies”.

We use the Global Industry Classification System (GICS) here. It consists of 10 sectors, 24 industry groups, 68 industries and 154 sub-industries. As a rule we would call all of the companies in the INFORMATION TECHNOLOGY and TELECOMMUNICATION SERVICES sectors IT companies, although the more appropriate international acronym is ICT… for Information & Communication Technology. We live in an age now where the computing power on our desktops is almost useless without the communications services and technologies that let us move information around.

But do we stop there? What about companies that have web sites that only sell goods and services on the Internet or provide other core web services. Are these tech companies?  I think many of us would argue that Amazon, Yahoo! and Google are all tech companies, but in many ways they don’t fit the traditional definitions. Google and Yahoo! would qualify as INFORMATION TECHNOLOGY in the GICS System, but Amazon would be placed in CONSUMER DISCRETIONARY. There are many other companies that we might associate with high-tech that are also classified as CONSUMER DISCRETIONARY… consumer electronics, photographic products (which are mostly digital nowadays), broadcasting & cable TV, and computer & electronics retail firms.

If we used the largest expenditures on R&D as a benchmark for what’s “high-tech” and what isn’t, we would have to include biotech and pharmacuticals companies as well, which would be classified as HEALTH CARE in the GICS. R&D costs for biotech are every bit as high (if not higher) than those associated with new computers or telecom gear.

Fortunately, there are specialized technology indexes in the US at least, and many have ETFs available, so you can easily diversify within a niche tech category. Such vehicles are sadly lacking in Canada. It would be foolish to invest in an ETF like the XIT, which is based on the S&P/TSX Information Technology Index, because your diversity wouldn’t extend beyond 5 companies.

So, where does this leave us?  Unfortunately, with handful of “tech company” interpretations, and I wouldn’t want  to leave yours out.  That’s probably why the Nasdaq Composite Index is still treated as the default tech index, even though so many specialized alternatives are available.  53% of the 2000+ stocks in that index are in the GICS INFORMATION TECHNOLOGY category. Add in some TELECOMMUNICATION SERVICES, HEALTH CARE (biotech) and some tech-oriented CONSUMER DISCRETIONARY and you have maybe 60%+ of the constituents. Hardly ideal, but once you consider that the top 10 holdings are INFORMATION TECHNOLOGY and HEALTH CARE, and those holdings account for 35% of the index, it starts to make sense.

Here are The Top 10…

• MICROSOFT CORP
• APPLE INC
• GOOGLE INC
• CISCO SYSTEMS INC
• ORACLE CORP
• INTEL CORP
• QUALCOMM INC
• AMAZON.COM INC
• AMGEN INC
• TEVA PHARMACEUTICAL IND ADR

Now, it’s a little known fact that Canada has it’s own Nasdaq Canada Index (^CND if you use Yahoo! Finance)… comprised of 46 Canadian companies listed on Nasdaq (and typically also on the TSX).  Here’s a breakdown of the two collections in terms of proportions of companies in each GICS category…

You’ll see that HEALTH CARE is a bigger percentage in Canada than INFORMATION TECHNOLOGY, but adding the two of them together gets us up to 45% of the list. The Canadian index has proportionately more INDUSTRIALS as well.

Now, lets review the 2009 performance of some of the various tech-oriented indexes in Canada and the US as they compare with the first three below, which show how the overall markets performed.

• S&P/TSX Composite Index… +27%
• S&P/TSX Venture Index… +80%
• S&P 500… +20%

• Nasdaq Composite…. +39%
• Nasdaq 100… +47%
• Nasdaq Canada… +64%

• Inter@ctive Week Internet Index… +68%
• CBOE Technology Index… +62%
• AMEX Biotech Index… +43%

It’s clear that the small resource companies that are the biggest part of the S&P/TSX Venture Index were the hands-down winner for 2009, but all of the technology indexes exceeded the other broader market measures by huge margins. Technology is certainly not a dormant sector anymore.

An ETF on the Nasdaq Canada index would be an ideal diversified investment vehicle, but apparently no one has shown any interest in offering one. So, if the ^CND continues to charge ahead this year, you should be watching the component stocks and buying at least a small portfolio of the better performing ones.

Caution is still indicated on the US side, even though the variety of tech stocks is so much better, as are the bid/ask spreads. The problem is the US dollar, which continues to slide in spite of short term rallies. As a Canadian investor you would have had to subtract at least 7% off of the gains on the US indexes above to adjust for currency loss once you repatriated your funds.

We think that tech stocks, however broadly or narrowly defined, will have a good run this year. It’s long overdue, and the fundamentals for the industry leaders keep looking better.