Tech investors letting more air out of an inflated trade

Peter Kenny
Peter Kenny

By Peter Kenny, chief market strategist for Global Markets Advisory Group and independent market strategist at Kenny & Co. LLC

Without question, the two most significant themes that have driven market direction over the past two weeks have been the bi-annual OPEC meeting (and subsequent selloff in crude) and the massive reversal lower late last week on the part of large-cap tech and software verticals. Both of those trades were called one day in advance of the follow through in the market as indicated in both last week’s and today’s media links.

In the case of crude oil, and by proxy the energy sector (XLE), investors would love to gain some insight into the trade from these relatively depressed levels. Clearly OPEC and non-OPEC members are wrestling with oversupply in the market, despite recently agreed to and extended production restraints.

It is significant to note that West Texas Intermediate crude closed last week for July delivery at $48.83/bbl, just fractionally above the level it was trading at in the last week of November. It was in late November that OPEC announced its production restraints. That policy shift fueled a massive trade higher in crude, both WTI and Brent. However, the combination of time, slack global demand growth, increased US production and production violations by OPEC members has led crude back to the level it was at before the production restraints were announced.

Crude oil makes a round trip (up, then down) to the price level hit just before OPEC’s initial production cut agreement. (Source: Bloomberg)

The themes that have thwarted OPEC’s effort to keep crude prices more elevated and relatively stable are very much still at play. As a result, I don’t see much in the way of price gains for crude in the near term. That said, lower pricing in conjunction with soft production restraints should certainly help establish a floor for crude, even if that floor is closer to $40/bbl for WTI crude.

Last Friday, the tech sector (XLK) found itself the target of aggressive selling—nearly across the board. The sector fell 1.8% on the day while the Dow (^DJI, DIA) Industrials actually gained fractional ground, closing at a record high (21,271.97). As a result, it was the sector’s worst weekly performance since last December. As if to underscore the tech-centric nature of the selling, not only did the Dow Industrials gain ground (0.42%), the S&P 500 (^GSPC, SPY) lost only 0.08%, closing nearly flat.

  • Apple Inc (AAPL) fell 3.9% percent; its biggest daily decline since April 2016.
  • Facebook Inc (FB) fell 3.3%; its biggest decline since November 2016
  • Alphabet (GOOGL, GOOG) ended down 3.4%, its worst day since June 2016.
  • Microsoft Corp (MSFT) fell 2.3%.
  • Nvidia (NVDA) closed down 6.5%.
  • Cloudera (CLDR) tumbled 15.6%.

A one-month chart of the Technology Select Sector SPDR ETF (XLK)

More air will be let out of the tech rally. (Source: Yahoo Finance)

Do we see follow-through in coming weeks? Yes, I do expect more air to be let out of this trade, though Friday’s sharp trade lower may not be repeated. On a relative valuation basis, tech and software stocks are expensive. Investors will look for relative value in financials (XLF) during this period of rotation. We saw a glimpse of that trade last Thursday and Friday. Of course, the rally posted by financials also had a great deal to do with Washington, D.C. and the congressional action on Dodd-Frank. This week’s likely move to raise rates by the FOMC will add a degree of tail wind to the trade, effectively adding some muted momentum to financials.

This week, investors will be keeping a close eye on tech, energy and financials. From an economic calendar perspective, this week is all about the FOMC meeting and announcement. Investors are still expecting a 25 bps (0.25%) move by the Federal Reserve this week despite recent employment reports that indicate that a degree of the momentum in the employment/inflation trade has dissipated.