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Your Forecast: Cloudy with a Chance of Diversification?

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January 26, 2017
Investors: Cloud Computing market and technology stock trends.
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The technology sector has been on fire of late, in part due to growth in the cloud computing space. With the recent push to new all-time highs in the major stock indices, some investors may be wondering if the sector is overvalued. And one segment in particular, cloud computing, has received a significant amount of attention.

"The technology sector has enjoyed a resurgence over the last few weeks as we have seen, illustrated by the Nasdaq setting recent all-time highs," says JJ Kinahan, chief market strategist at TD Ameritrade.

"Many are wondering if there is room to run further to the upside. Retail investors may want to be careful here, and if they do purchase some of these stocks here, it should only be a fraction of their portfolio so that if the sector does experience some downward movement, that may create a buying opportunity at better levels.  As with most investments, when the product is near all-time highs one should be careful upon entering," Kinahan says.

What Exactly Is The Cloud?

The cloud simply refers to the notion that, instead of accessing information solely from a hard drive sitting under your desk or on a server, documents, pictures, information or other data can be accessed from anywhere one has Internet access. "It’s a transformative technology with immense growth potential," says Neena Mishra, director of ETF research at Zacks Investment Research.

"As our world is becoming increasingly digital and interconnected, many companies now prefer to rely on cloud-based service providers for highly specialized services so that they can focus on their core businesses. Switching to cloud also helps them cut costs, optimize resources and increase efficiencies," Mishra says.

Simply look around your house or your office. "Your world is moving more and more to the cloud," says Scott Kessler, deputy global director, equity and industry research at CFRA. He notes that the two dominant technology megatrends are 1) mobile and 2) the cloud. "They go hand in hand. Mobile is the gateway to accessing the cloud," Kessler says.

Forecast: Increasing Cloudiness? 

Simply put, it's big and getting bigger. According to a new forecast from the International Data Corporation (IDC) Worldwide Quarterly Cloud IT Infrastructure Tracker, total spending on IT infrastructure products (server, enterprise storage, and Ethernet switches) for deployment in cloud environments will increase by 18.2% in 2017 to reach $44.2 billion. 

"Keep in mind that this is only a piece of the overall cloud market/opportunity," Kessler says.

A recent McKinsey & Company report says the cloud debate is over. Businesses are now moving a material portion of IT workloads to cloud environments. The impact will be considerable, for consumers and vendors of technology alike." Projections in that report "have made me quite optimistic about the growth potential," of the cloud space, Mishra says.

Looking ahead, Mishra has a positive outlook for the broader technology sector as well as the cloud computing sub-sector. "The trend of companies eliminating their own data centers and shifting their applications to cloud continues to accelerate.  Cloud applications are also increasingly being used in the Internet of Things, mobile computing and gaming. The technology has continued to evolve, and tremendous progress has been made in the past few years, Mishra says.

How to Invest?

As investors look for opportunities to harness the potential of this growing space – it can be somewhat difficult to actually define. There is no official "Cloud" sector. "It's not an industry or a category – it is an ecosystem," Kessler says.

Within the cloud space there are some categories, which can include so-called "mega-providers" of cloud infrastructure and solutions – Amazon, Microsoft and Alphabet can fall into this category, Kessler says.

Then there are companies that are doing things to enable the cloud, such as networking companies or even Netflix, which is "an entire television channel based entirely on the cloud." Then there is a company like Salesforce.com, "which has turned into a powerhouse by focusing on the cloud and adding products around that," Kessler says.

Might the Space be Overvalued?

Kessler points to 2017 price/earnings estimates for the technology sector and says "we don't see it as overvalued." P/E estimates for the tech sector in 2017 stand at 16.9% versus 17.4% for the S&P 500 overall. "I would hardly say these stocks are overvalued, generally speaking. The balance sheets are bigger and stronger in tech than in other areas," Kessler says.

There are a number of ETFs that provide exposure to this space, Mishra adds. These include the First Trust Cloud Computing ETF (SKYY), iShares U.S. Technology ETF (IYW), SPDR S&P Technology ETF (XLK), Vanguard Information Technology ETF (VGT) and PowerShares NASDAQ Internet ETF (PNQI), which also provide some exposure to this space, she says.

But Kinahan’s words from the top of the article are worth repeating: “As with most investments, when the product is near all-time highs one should be careful upon entering."

Carefully consider the investment objectives, risks, charges and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.

ETFs can entail risks similar to direct stock ownership, including market, sector, or industry risks. Some ETFs may involve international risk, currency risk, commodity risk, and interest rate risk. Trading prices may not reflect the net asset value of the underlying securities. Commission fees typically apply.

The risks related to investing in cloud computing companies include service disruptions, interruptions or delays, security breaches and privacy concerns, evolving Internet regulation and related foreign or domestic regulations. Also, the company business models may not prove to be successful.

Asset allocation and diversification do not ensure a profit or eliminate the risk of investment losses.