Over the course of the previous week, an enormous downturn was evident across the spectrum of tech stocks. The Top 25 Nasdaq-100 constituent stocks’ momentum largely flashed red:
The one bright spot was MercadoLibre with a very strong showing while Apple, Broadcom and Adobe effectively treaded water.
Meanwhile, the small-cap Russell 2000 was a mixed bag that – on balance – was a little less red:
Used-car dealership Carvana, a handful of medtech/biotech stocks – chiefly BridgeBio and Inozyne – and financial firms such as United Insurance and consumer lending platform Upstart – helped carry the week.
Giants and small caps aside, an all-important barometer for the American economy’s forward outlook is the S&P 500. Here too, the past week has been somewhat mixed:
Tesla, Advanced Micro Devices and Nvidia – stocks that are important constituents of America’s “Magnificent Seven” – had seen the most substantial impact on their momentum in quite some time.
The emerging fact pattern lends support to the notion that an attempt at sector rotation is in motion.
A Breakdown: Weighted vs Equal, Tech vs Ex-Tech
“Tech” has been steadily enveloping the growth story in American bourses for over two decades now. One means of separating and analyzing the effect of pronounced tech stock valuations on broad index/ETF performance lies in considering SPX versus the S&P 500 Equal Weight Index (SPXEW); the latter essentially “flattens” the effects of market capitalization to only consider momentum of all constituent stocks in unison.
In net performance from January 2007, i.e. just before the Global Financial Crisis (or “GFC”) till the 25th of July, both indices had delivered over 300% in returns, with the Equally-Weighted Index marginally leading by 3%.
The performance graph is highly suggestive of the notion that tech overvaluation and its contributory performance only came to the forefront in the final week of March 2020. However, it bears noting that while the Equally-Weighted Index leads in this broad window, there is some strength to the notion that pronounced valuation exists in tech: from the “market bottom” of March 24, 2020 till the present, the S&P 500 is up 17.4% while the Equally-Weighted Index is up 12%. This 5.4% “spread” is no small matter.
Going by calendar year across the broad window, it is evident that the relative overvaluation has seldom been a sustained cushion. Outside of 2008, the “spread” has an average of 3.33% and a median of 3.44% across complete calendar years.
Throughout the broad window, the YTD spread is second only to that seen in 2009 wherein the Equally-Weighted Index prevailed over the market cap-weighted index. This adds context to the cooling of momentum in the “Magnificent Seven” in particular and tech in general: it is absolutely in keeping with trends seen in the past.
Next: to consider the relative effect of tech overvaluation on the broad index, lets consider the performance of the Invesco S&P 500 Equal Weight Technology ETF (RSPT) versus that of the ProShares S&P 500 Ex-Technology ETF (SPXT) which doesn’t track an equally-weighted index but does exclude tech constituents.
Note: Effective on June 6, 2023 the Invesco S&P 500 Equal Weight Technology ETF’s ticker changed from RYT to RSPT. No other changes were made.
An early lead in SPXT’s lead in performance during the decline of Q3 2022 (which meant that it did better than its tech opponent) was largely erased in the burgeoning appetite for tech that has been in play since Q4 2022. However, it bears noting that the “ex-tech” has shown far less volatility than the “tech”.
An overview of the month-wise performance of the two instruments reveals that despite being equally-weighted, the “tech” instrument has generally outperformed the market cap-weighted “ex-tech” instrument. However, the spread in performance is trending towards a decline which is empirically neither novel nor unexpected.
In fact, in the month till date (MTD), the spread is trending towards settling close to the 1-2% range by the end of the month. This is another sign of tech overvaluation cooling off: the average of month-wise spreads in the past one year is 2.66% while the median is 1.88%.
In a market which has witnessed a gentle rise in retail investor volumes and optimism, institutional investors have continued to reign supreme – albeit with guarded tones. For the first time since July 2020, traded volumes of the Invesco S&P 500 Equal Weight ETF (RSP) – which tracks the SPXEW – had seen a surge well in excess of that in SPY in Q2 of this year.
In absolute terms, however, SPY typically sees volumes that are 15-20X that of RSP. In the current month, both have plunged.
Three factors that will likely clash over the next few days. The first: a slew of upcoming earnings releases in both “tech” and “ex-tech”. Across the board, they can be expected to be “so-so”: overall positive but no massive standouts. In the past five years, even a “so-so” release would have triggered a strong rally manifesting for a quarter or even longer, given the large variety of players. In the present day, there are fewer players and they’re largely either “institutional” or “professional”. However, of the entire gamut of sectors, “tech” has tended to attract higher conviction from the clients of said “institutionals”.
The second factor is that sector rotation is both desirable and natural, thereby making it expectable. The affordability crisis is by no means over: easing of monthly CPI or not, the accrued elevation of costs for the average American consumer ensures that any over-optimistic forward outlook in any company with a broad consumer base would be (and should be) questionable.
The third factor is the relatively shallowness of the investor pool. Even a relatively smaller lot of trades are manifesting as a rally in intraday sessions with an inevitable correction either later on in the day or week. Simply put: while the market is looking upwards, there isn’t a whole lot of support for an overly-high jump.
Overall, there is a lot of potential for finding a slew of decently-priced securities outside of “tech” while Big Tech can be expected to continue to slide in valuation over the course of this quarter. What will confound this would be momentary spikes sparked by modest buy-ins in a shallow market.
For professional investors with a flair for tactical trading, there are a couple of Exchange-Traded Products (ETPs) to consider: SP5Y gives leveraged exposure to the upside of the S&P 500 while SPYS does the same on the downside. Similarly, QQQ5 gives leveraged exposure to the upside of the Nasdaq-100 while QQ3S does the same on the downside.
Sandeep joined Leverage Shares in September 2020. He leads research on existing and new product lines, asset classes, and strategies, with special emphasis on analysis of recent events and developments.
Sandeep has longstanding experience with financial markets. Starting with a Chicago-based hedge fund as a financial engineer, his career has spanned a variety of domains and organizations over a course of 8 years – from Barclays Capital’s Prime Services Division to (most recently) Nasdaq’s Index Research Team.
Sandeep holds an M.S. in Finance as well as an MBA from Illinois Institute of Technology Chicago.
Julian joined Leverage Shares in 2018 as part of the company’s primary expansion in Eastern Europe. He is responsible for web content and raising brand awareness.
Julian has been academically involved with economics, psychology, sociology, European politics & linguistics. He has experience in business development and marketing through business ventures of his own.
For Julian, Leverage Shares is an innovator in the field of finance & fintech, and he always looks forward with excitement to share the next big news with investors in the UK & Europe.
Violeta joined Leverage Shares in September 2022. She is responsible for conducting technical analysis, macro and equity research, providing valuable insights to help shape investment strategies for clients.
Prior to joining LS, Violeta worked at several high-profile investment firms in Australia, such as Tollhurst and Morgans Financial where she spent the past 12 years of her career.
Violeta is a certified market technician from the Australian Technical Analysts Association and holds a Post Graduate Diploma of Applied Finance and Investment from Kaplan Professional (FINSIA), Australia, where she was a lecturer for a number of years.
Oktay joined Leverage Shares in late 2019. He is responsible for driving business growth by maintaining key relationships and developing sales activity across English-speaking markets.
He joined Leverage Shares from UniCredit, where he was a corporate relationship manager for multinationals. His previous experience is in corporate finance and fund administration at firms like IBM Bulgaria and DeGiro / FundShare.
Oktay holds a BA in Finance & Accounting and a post-graduate certificate in Entrepreneurship from Babson College. He is also a CFA charterholder.
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