Tech Boom Turns To Bust As The Nasdaq Has Its Worst Week Of 2017

Friday was a great day for the market as most sectors were up. Energy and the financials did well as the S&P energy sector was 2.48% and the S&P financials sector was up 1.93%. However, in the afternoon the technology sector had a bit of a flash crash led by NVIDIA which was down 6.46% on the day. The Big 5 technology stocks were all down sharply. You can see the FANG’s crash in the chart below. Amazon lost $17 billion in market cap in 5 seconds. The Nasdaq fell 1.80% as it had its worst week of the year.

One of the reasons for NVIDIA’s crash was the negative note by short seller Andrew Left from Citron Research. However, the main culprit of this selloff was likely fact that all the momentum traders were leaning in one direction. Just like with bitcoin and the 1990s tech bubble, when every trader is leaning in positively, the market is vulnerable to a sharp reversal. The chart below shows the volume in the triple Qs which is the Nasdaq 100 ETF. As expected, volume skyrocketed way above the 30-day average as traders scrambled to react to the crash.

It’s important to understand that while this selloff is big relative to the action we’ve seen in tech this year, it’s only a blip on the charts. The Nasdaq is still up 15.32% year to date. The chart below is of the Semiconductor ETF. The SMH had its highest volume day of the year. Total year to date returns are still 19.51%. The 3.81% selloff only gave back 6 days of gains.

As I said, the selloff in tech is simply the stocks being a victim of their own success. As you can see from the chart below, the FAANG market cap as a percentage of the S&P 500 has almost doubled since mid-2013. This doesn’t imply a crash is coming because their earnings are also up. I don’t see this selloff lasting more than a few days because there wasn’t any fundamental reason for it. With record profits from the tech stocks and oil in the mid-$40s, I don’t see how energy stocks can outperform tech stocks over the next few months. Obviously, when you buy the momentum/tech stocks with the worst fundamentals which would be Tesla, Netflix, and Snap, you’re taking more risk than if you buy Facebook or Alphabet.

Besides the note by Andrew Left which was bearish on NVIDIA, another note which may have spooked the market was by Goldman Sachs. Goldman Sachs pointed out the obvious which is that the Big 5 tech names which are Alphabet, Microsoft, Apple, Facebook, and Amazon are going up in a hyperbolic fashion. The momentum factor traded at a 1.8 standard deviation above its 3-year average as investors piled into these risky stocks. As you can see in the chart below, FAAMG had a lower 6-month realized volatility than consumer staples. That’s absurd because the fundamentals of technology stocks are subject to much more risk because of competition. The disruptive nature of the technology sector makes it like fashion- one day you’re in and the next day you’re out.

As I have mentioned previously, there is a belief on Wall Street that the Big 5 tech stocks will have permanently high margins. That’s a logical leap I’m not willing to make given the fact that some of these firms have only become popular in the past few years. Facebook only had $153 million in revenue 10 years ago. The idea that Facebook has a lock on its users which can choose to spend their time on something else seems unrealistic. The internet will evolve in ways we can’t imagine now. It’s much more likely that Heinz will still have a dominant position in the ketchup market in the next 10 years than it is Facebook will still dominate social media.

Goldman Sachs mentioned that technology stocks have begun to have a negative correlation to interest rates like the consumer staples stocks. This is unusual as tech stocks have gotten beat up when the Fed has raised rates in the past. Technology stocks are now looked at as safe bets even as they rise parabolically. To be fair, the current environment for interest rate hikes is unusual because inflation is declining as the Fed raises rates. The goal of raising rates is to rein in inflation, but inflation was never getting out of hand. Inflation hurts tech stocks as their revenue growth in the future has less real value. Therefore, I’d summarize the reason for tech stocks acting like staples is because of the change in investor sentiment and because inflation is falling.

As you can see from the chart below, the trend Goldman was talking about reversed Friday as the S&P growth factor crashed and the S&P value sector rallied. This factor risk is something I have been mentioning in previous articles. It’s not a great idea to buy a factor that many passive investors are putting money into to generate excess returns. Being a true passive investor means putting money to work when the market goes up and when it goes down. It’s easy to do so when the market is up, but much harder when it’s crashing. The reason why passive investing is a bad strategy is because investors who are relentlessly buying stocks at these expensive valuations are going to find it tough to buy when losses mount.

Conclusion

The Nasdaq finally had a mini-correction on Friday. This was caused by the excess speculation which led to vertical moves in stocks like NVIDIA. When a stock has a vertical move, anything can cause it to plummet. After this selloff washes out, I don’t see the selling pressure continuing because there has been no fundamental change in earnings from these firms. There might be a change soon, but we must wait for the Q2 earnings next month to see if that occurred. The other benefit tech stocks have is the ECB is continuing to pump $60 billion per month into the bond market which is boosting liquidity and causing risk assets to rise. If the Fed decided to be more dovish in the next meeting like the ECB was because of falling inflation, stocks would likely soar.

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