Not only is technology the largest sector weight in the S&P 500, it is the best-performing group in the benchmark U.S. equity index this year. The Technology Select Sector SPDR (XLK), the largest exchange-traded fund (ETF) by assets tracking the sector, is up 18.7 percent year to date, an advantage of exactly 900 basis points over the S&P 500.
Underscoring recent strength among technology ETFs, of the nearly 230 ETFs that hit record highs last Friday, more than 30 were technology funds. XLK barely missed out on the illustrious milestone, but rival cap-weighted tech ETFs are ascending to new highs as big-name technology stocks, such as Apple Inc. (AAPL), Microsoft Corporation (MSFT) and Facebook, Inc. (FB), drive the sector higher. (See also: QQQ vs. TQQQ: What's the Difference and Which Is Better?)
However, some analysts have doubts about the technology sector. For example, AltaVista Research tagged XLK with an underweight rating in a recent note. From that research firm, an underweight rating implies rich valuations or slack fundamentals. Technology is not excessively valued relative to the broader market. For example, based on the research firm's 2017 estimates, AltaVista expects that XLK's price-to-earnings ratio will be 19.2 compared to 18.4 for the S&P 500. The research firm estimates XLK's price-to-cash-flow ratio to be 13.7 compared to 13.1 for the S&P 500.
For the week that ended June 1, investors pulled $581.3 million from XLK, resulting in XLK's second quarter flows data turning negative. On a year-to-date basis, investors have added more than $755 million to the technology ETF. (See also: A Look at the Technology Sector SPDR ETF.)
Still, traders appear reluctant to bet against XLK. The ETF's short interest, while slightly higher on a month-over-month basis, is just 10 percent, according to AltaVista data. Five sector SPDR ETFs have larger percentages of shares outstanding sold short than XLK, four of which have short interests that are more than double that of XLK. Confirming that investors are mostly bullish on XLK, the ETF's shares outstanding have surged 10 percent over the past year. XLK holds 75 stocks with a weighed average market value of $340.7 billion. Apple and Microsoft combine for over one-quarter of the ETF's weight.
"Although profitability in terms of margins and ROE remains exceptionally high, earnings growth has declined in recent years, and long-term EPS growth expectations are just modestly better than the S&P 500 overall," said AltaVista. "However, surging share prices in the past few months have caused the sector to break out above its P/E trading range of recent years ... in turn diminishing future appreciation potential to about average, in our opinion." (See also: Big Money Flows Into Big Tech ETFs.)