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How Tax Reform Crushed Technology ETFs

Sweta Killa
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The hottest sector, technology, is the worst victim of tax reform developments. Stocks in this sector have been on a wild ride over the past one week with most of them piling up huge losses. This is because investors are flocking to companies expected to get a bigger boost from the tax reform, which is on its way. It is now pending only the consolidated bill and the final signature by Donald Trump within Christmas (read: Senate Passes Tax Bill: 5 ETFs to Buy Now).

Notably, this year’s top performing sector slid about 4% over the past week. The ultra-popular Select Sector SPDR Technology ETF XLK shed 1.7% over the past five days compared with losses of 0.3% for the broad market fund SPY and 1.3% for Nasdaq ETF QQQ. XLK saw outflows of about $540 million in the same period.

How Tax Reform Could Hurt The Sector?

According to S&P Global data, the technology sector pays an effective tax rate of 18.5% — the third lowest among U.S. large caps. As such, a reduction of tax rate to 20% would not really benefit the sector. Additionally, the retention of the corporate alternative minimum tax in the Senate version of the tax bill as well as the R&D tax credit is a concern for tech firms (read: 4 Sector ETFs & Stocks Set to Explode Higher on Tax Cuts).

As tech companies spend higher on research and development, they claim tax credits. However, by lowering the corporate tax rate, it might be harder for them to get this benefit. All these factors are weighing on investors’ sentiment on the technology sector.

ETF Performances

Among the worst performers over the past week, semiconductor ETFs declined the most with PowerShares Dynamic Semiconductors Fund PSI and First Trust Nasdaq Semiconductor ETF FTXL plunging 8.8% and 8%, respectively. The hottest ETFs of this year — Guggenheim China Technology ETF CQQQ and KraneShares CSI China Internet ETF KWEB — also fell about 8% and 7%, respectively.

The other poor performers were PowerShares DWA Technology Momentum Portfolio PTF and PowerShares Dynamic Software ETF PSJ, each losing about 7% (read: Tech ETFs & Stocks Tumble: Is it a Solid Entry Point?).

What’s Ahead?

Technology is still the best-performing sector this year, having generated twice the returns as the S&P 500 index through the first 11 months of the year. The outperformance is likely to continue heading into the New Year, given expectations of strong earnings, improved overseas industry demand, and innovative technologies.

The emergence of cutting-edge technology such as cloud computing, big data, Internet of Things, wearables, VR headsets, drones, virtual reality devices, and artificial intelligence will continue to fuel growth for the sector. With the global economy gathering strong momentum, technology stocks will continue to outshine and be less susceptible to interest rates or deregulation (read: 7 Top-Ranked Tech ETFs on Unstoppable Rally).

Though the tech titans will benefit less from corporate tax cuts, they hoard huge cash overseas and are poised to benefit the most from Trump's repatriation policy. Tech giants like Apple AAPL, Microsoft MSFT, Cisco CSCO, and Oracle ORCL combined have nearly $500 billion cash and cash equivalents held overseas, according to recent regulatory filings.

Further, a pick-up in the economy and better job prospects will provide a solid boost to economically sensitive growth sectors like technology, which typically perform well in a maturing economic cycle (see: all the Technology ETFs here).

Moreover, after a brutal decline, most tech stocks have become cheap at current levels, offering a nice entry point for investors. As a result, investors could do some bargain hunting on ETFs that have become value picks. Most of the tech ETFs have a Zacks Rank # 1 (Strong Buy) or 2 (Buy), suggesting outperformance in the coming months.

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