Tech Surges in 3Q as Growth Sectors Lead Wall Street Higher

Despite a host of global economic challenges through the course of 2016, in the third quarter U.S. equity markets once again proved their resilience as the major averages capped the thee-month period higher.

Posting positive gains on the session Friday, the Dow Jones Industrial Average ended the third quarter up 2.1%, while the S&P 500 gained 3.3% and the Nasdaq surged 9.7%.  Growth sectors, or those sensitive to economic shifts, tended to outperform: Technology led seven of the 11 S&P 500 sectors higher with a gain of 12.4%, followed by financials, industrials, materials, and consumer discretionary. Defensive sectors including consumer staples, telecommunications, and utilities posted declines for the period.

Momentum came from a range of factors including Federal Reserve-driven liquidity, low interest rates, and third-quarter earnings growth, said Terry Sandven, chief equity strategist at U.S. Bank (NYSE:USB). Second-quarter earnings results showed, 60% of technology companies beat estimates on both profit and revenue, second only to the health care sector with a 63% beat rate, according to September data from S&P Global Market Intelligence.

In addition, buzz surrounding mergers-and-acquisitions activity helped drive momentum on the tech-heavy Nasdaq. Peter Kenny, senior market strategist at Global Markets Advisory Group pointed to rumors about a potential Twitter (NYSE:TWTR) buyout, which has sent shares up more than 36% quarter-to-date, alongside Microsoft’s (NASDAQ:MSFT) purchase of professional networking site LinkedIn (NASDAQ:LNKD), and small-scale buys from Salesforce (NYSE:CRM).

“Twitter is not on the tape yet, but that has certainly driven speculation that’s driven the whole social-media space higher and brought a lot of volatility into the space,” Kenny said.

While economic data have painted a mixed picture of the economy over the last three months, Kenny said there are critical portions, including the labor market and inflation, that have weathered a series of storms including a sharp selloff to start the year, global central banks – with the exception of the Fed – driving rates into negative territory, and the late-June Brexit vote in which the U.K. ended its membership in the European Union.

The market’s ability to bounce back has helped drive investor confidence higher as growth sectors emerge as standouts on the year.

“Growth companies tend not to trade on current, but projected valuations. If people are willing to pay up for a sector that’s trading at a premium predicated on future earnings, that’s a clear correlation to investor confidence,” he explained. “There is a big risk-on in tech partially because of M&A and partially because people are finding growth opportunities outside the sector few and far between.”

Looking ahead, the fourth quarter of the year tends to be a strong period for U.S. equity markets: Since 1945, the S&P 500 has posted an average gain of 4% during the period, and rose in price more than 70% of the time, according to data compiled by S&P Global Market Intelligence U.S. equity strategist Sam Stovall. Historically, cyclical sectors including consumer discretionary, industrials and technology posted the greatest returns while energy, financials, telecom, and utilities lagged.

U.S. Bank’s Sandven sees few exceptions to that trend heading into the final three months of 2016, and favors technology, health care, and select consumer discretionary stocks through the end of the year, seeing very little risk of recession in 2017.

“We look for equities to grind higher with chop,” he said. “Volatility will remain into the year end and into 2017…we need earnings to move higher to warrant considerably higher stock prices.”

In the near term, Sandven expects a holding pattern for U.S. stocks with two weeks before third-quarter corporate reporting season kicks into high gear and as investors wait for the outcome of the presidential election and direction from the Fed on the possibility of a December rate hike.

“There are uncertainties associated with the election coming to a head and seasonality tendencies are favorable,” he said. “We like the outlook for the year end, but it’s sideways trending until we get a picture of the economy’s health through the lens of company management.”