Mutual Fund Investing: Tech Winter

Now that summer is winding down, its time to look ahead. Historically, from the end of October to the end of February, tech stocks tend to outperform the overall stock market. This phenomenon is something I call "Tech Winter." You can think of it as the prime time to overweight tech. While it may seem strange that tech stocks follow a seasonal pattern, there are actually several factors I’ve found that can explain it.

#1: Fourth-Quarter Spending

The first is fourth-quarter spending by corporations. Over the course of a year, information technology managers tend to hold back some of the money in their budgets. That way they won’t be caught penniless in case of a late emergency or some technological innovation that becomes necessary to stay competitive as the year progresses.

But as year-end approaches, this unspent money needs to be used. Why? Because the tech managers know that if they have something left over, their budget for the next year will probably be cut (see also, “Apple’s 3G Boosts Grim Corporate IT Outlook“). They don’t want that, so they spend freely in the year’s final months. That spending also has tax implications for companies that want to cut down on what they owe the government.

#2: European Purchasing Power

A second, separate factor is Europe. European purchasers account for about 35% of U.S. technology orders. During the fourth quarter, they do a significant amount of buying. This happens year after year because of the longer summer vacations European companies give their workers. Orders slack off while they’re away, and when they return, orders begin rising in the fall and through the winter, often hitting a peak in the last few months of the year.

#3: Year-End Discounts

A third factor is year-end discounts. Hardware companies, preparing 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. “Tech Winter” draws to a close in the first couple of months of the new year, when tech companies restock their inventories and a new purchasing cycle commences. As this happens, tech stocks don’t necessarily under-perform the stock market as a whole, but they do become less predictable in their movement.

Okay, that’s the background. Now here’s the proof:

Proof-Positive Profits

When I’ve looked at this four-month period during each of the last 22 years, Vanguard’s oldest and tech-heaviest funds have significantly outperformed 500 Index (VFINX), which currently has about a 16% tech weighting.

Over just the last 10 years, the numbers are again pretty convincing. Only Growth Index failed to outperform 500 Index, on average, simply matching its average 4.3% return for the four-month Tech Winter period.

The trend holds true for a number of tech-heavy Fidelity funds. (Jim Lowell, editor of Fidelity Investor, was gracious enough to supply this information.)

(But please don’t get too eager! If “Tech Winter” were a sure thing, there wouldn’t be any need for my newsletter, The Independent Adviser for Vanguard Investors, and my diversified Model Portfolios!)

I don’t recommend making major investment decisions based upon short-term trends such as “Tech Winter.” Year-to-year results can vary immensely. Between Nov. 1, 2000, and Feb. 28, 2001, for instance, Fidelity’s tech sector funds, for instance, faced losses ranging from Select Software’s 33.2% decline to a 45.2% loss for Select Computers. Compare that to what looks like a minimal 12.9% drop for the S&P 500.

Should you want to both own great funds and try to make a bet on a good tech season, I announce my favorite choices among funds with heavy tech holdings and managers who know how to use them every November in my monthly newsletter, The Independent Adviser for Vanguard Investors.  Each month I help my subscribers make more than 144% more than the average Vanguard investor.  And with my risk-free money-back guarantee, you have nothing to lose, but a ton to gain.