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Can tech stocks stop the rot?


4 September 2020

US stocks are set to fall further on Friday, with futures now in the red, led once more by tech stocks. The Nasdaq Composite Index saw a 4.96 percent plunge on Thursday, which was its biggest single-day decline since June 11th. The Nasdaq 100’s 5.23 percent dive yesterday was its steepest since March. The selloff was likely fuelled by concerns that its lofty valuations may prove unsustainable, triggering a wave of profit-taking which also left a trail of carnage in the options market.

From a technical perspective, the drop was necessary and healthy, as it brought the Nasdaq’s 14-day relative strength index (RSI) away from overbought levels. And such a move shouldn’t come as a surprise. Since the market began exiting the bear market in March, the index has seen a pullback whenever its RSI hits or crosses above the 70 threshold, which denotes overbought levels. This week’s drop may have been more violent given that the Nasdaq had been allowed to gather so much froth; the RSI even breached 80 earlier this week.

Perhaps market participants are rebalancing or cashing out ahead of the Labour Day weekend. How stock markets perform once trading resumes next week would be more indicative of whether a trend is truly forming.

It remains to be seen whether tech counters have had their time in the sun, and whether the rotation into laggard sectors could leave a big dent in Big Tech’s near-term performance. Even after Thursday’s selloff, valuations remain stretched, with the Nasdaq Composite Index’s PE ratio still above 60. However, should this pullback extend into a 10 percent correction, that may prove too tempting a buying opportunity for fans of Big Tech, who could then swarm back in and restore the Nasdaq to its upward trajectory.

After all, the fundamental backdrop still bears major elements that are conducive for the tech sector over the long term. The Fed is willing to let the US economy run hot, which is supportive overall of equities, while the ‘new normal’ ensures the world remains reliant on Big Tech, even as the pandemic rages on in major economies.

It’s also important to note the looming potential catalysts. A US non-farm payrolls report that reads better than the expected 1.35 million print could stop the bears in their tracks on Friday, prompting the resumption of equity gains. Then, should the next round of US fiscal stimulus be approved as the Senate reconvenes next week, that could also reignite tailwinds in benchmark US indices.

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