By Michael Wursthorn
Technology stocks are up 26% this year, and some Wall Street analysts say the sector is a good refuge following worrying signs from the bond market.
But it all depends on where in tech investors put their money.
Tech stocks have a history of outperforming the broader market following a yield-curve inversion, analysts at Bank of America Merrill Lynch say. Since 1965, the sector, on average, beat broader benchmarks in the 12 months following such an event. So far this year, the S&P 500 is up 15%.
That history offers hope to investors after yields on the 10-year U.S. Treasury notes briefly fell Wednesday below two-year yields. That type of inversion, the first since 2007, has been one of the stock market's most reliable signals of a recession since 1978, and it has investors and analysts alike scrambling to rejigger portfolios in case the economy starts sputtering.
Bank of America's analysts highlight Vanguard's Information Technology exchange-traded fund for its low expense ratio and price momentum. In addition, the fund carries a lower exposure to the beleaguered semiconductor industry.
As one looks deeper into tech, IT-services stocks have fared the best, rising 32% this year. That is no surprise as several companies in the group have reported some of the strongest earnings results for the second quarter. PayPal Holdings Inc., for example, increased earnings by 47% from a year earlier, while Automatic Data Processing Inc.'s profit grew 22%.
Both stocks are up more than 26% on the year and have mostly weathered the latest bout of volatility.
But that performance comes at a premium. IT-services stocks look pricey, trading at 22 times earnings projected over the next 12 months, near the group's highest levels in years and well above the broader tech sector and the S&P 500.
Only software stocks, which have risen nearly 29% this year, are more expensive, with a forward-looking P/E multiple of 24.
Among the cheapest, but also the riskiest amid trade tensions and signs of economic weakness, are semiconductor stocks. They trade at 14 times their earnings. Second-quarter earnings have pulled back about 28% from a year earlier, and third-quarter earnings could contract even more, with analysts estimating a 30% pullback.
One bright spot is Nvidia Corp. The chip maker reported solid earnings thanks to a boost from gaming and raised its forecast for the year, sending shares up 7.3% on Friday. The stock is up nearly 20% year-to-date and analysts at Bank of America say the company has the potential to rise another 41%.
Write to Michael Wursthorn at Michael.Wursthorn@wsj.com