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There is a red flag in today’s market that many investors are unaware of: the recent dominance of the technology sector, particularly large tech stocks that are part of both the Nasdaq 100 Index and S&P 500 Index. While they are currently market darlings, we have seen this pattern before and it is a laugh riot for aggressive growth investors. Then, it becomes a financial tragedy.
Here is another glance at what is going on, with historical context. In this graph, I have plotted the 1-year “trailing” total return of the S&P 500 (represented by symbol SPY) versus the 1-year trailing total return of the Technology sector of that same S&P 500 (represented by symbol XLK). I went back to the start of the year 2000 and the data is monthly, so there were 208 monthly observations, the last being 4/30/17. The current return of XLK over the past year is 31.33% versus an SPY return of 17.78%. Neither is too shabby, but what I want you to focus on is the spread, or difference between them, which is on a separate graph just below. As you can see, Tech sector outperformance is approaching a level it has rarely touched in the last 17 years. In fact, the outperformance of about 13.6% over the past 12 months ranks in the top 8% of all observations this century. So, Tech is on a roll.
Now, let’s look at the chart below, and we will see that with few exceptions, Tech outperformance has only been this strong either just before or just after a major market decline. In fact, there were only a few times when S&P Tech outperforming S&P 500 by at least 10% in a 12-month period was not meaningfully tied to a bear market.
As I see it, when investors go ga-ga over tech stocks, one of two things is happening: a strong bull market is getting tired and people get so excited and urgent to buy “growth” stocks, they just pile into big tech names. I think that is what is happening now. The other scenario in which Tech dominates is when a bear market has just swept through, and investors are in the early stages of re-kindling their relationship with the stock market. At that point, tech stocks are relatively cheap and their growth potential makes them attractive buy candidates.
Here is the problem for tech-laden investment portfolios today: we did not just have a bear market. That leaves only the other scenario, which is that urgency to own tech stocks more than other sectors, just before the stuff hits the fan. Once again, I don’t know when this will occur, but like hedge fund king Ray Dalio said last week and other prominent voices have conveyed lately, this bull market is old and tired, and strong tech outperformance again appears to be its last gasp. That means that investors should tread extremely carefully in this sector and consider what other sectors might be more reasonably priced.
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Comments provided are informational only, not individual investment advice or recommendations. Sungarden provides Advisory Services through Dynamic Wealth Advisors.