Is tech ready to relinquish market leadership?

What happens when the market starts to fade the tech rally? Will we see a rotation into the broader market, or will investors sell and move to the sidelines? Given what we’ve seen thus far, evidence points toward a broad rotation from tech into other sectors, rather than selling outright and moving to the sidelines. Here are some of our thoughts on recent equity market happenings.

One of the risks we are watching for in the second half of 2024 is the potential for tech to lose its leadership. Why? Maybe earnings expectations are too lofty? Maybe the artificial intelligence trade has pulled too much growth forward and it starts to slow at the margin? Maybe firms’ tech spending/capital expenditures get exhausted? Who knows. But the bigger issue to consider is how does the market handle such a shift? We see two routes for this: Investors can rotate to other segments of the market, or investors can sell and move to the sidelines in cash.
 

Sector rotations are the lifeblood of bull markets

We believe rotating into other sectors of the market would be a positive for the broader markets. Breadth would widen out and support a broad-based rally. The headline index level might soften, given the weight tech carries. But gains are still to be had in other areas of the market such as value, cyclicals and equally-weighted indices. Sector rotations are the lifeblood of a bull market. The bull market would continue – just not in tech. Selling outright and moving to cash would be a negative for the markets. There would be no rotation here. Money would move out of the market and to the sidelines. Tech would likely lead the market lower. But the other areas of the market would also weaken, as there would be little support from new buying coming in from the tech proceeds.

Based on the evidence thus far, we are seeing rotations taking place – and not outright selling and moving to the sidelines. Investors have been selling tech names and buying other sectors of the market. Will this trend continue? It remains to be seen. But what this behavior is telling us is investors still want exposure to the equity market and are not looking to fade equity strength.

We did a little analysis looking at tech-led sell-offs since the start of April 2024. The ground rules: The Nasdaq 100 needed to underperform the S&P 500^®, AND the worst-performing S&P 500^® sector had to be Information Technology on that day. This helps to ensure that the market sell-off was tech driven. Well, what did we find?

In short – the market was rotating and not selling and moving to the sidelines. Things to note in the table below:

• In the days that met our predefined criteria, check out the percentage of advancing names in the S&P 500^®.
• In most cases, the percentage of advancing issues in the S&P 500^® was still solid.
• In the most recent cases, advancers outpaced decliners on the day. 
• And on those days when tech was getting walloped (down 2%–3%), other sectors were putting up double-digit gains.

Bad days for tech, better times for broader market

Bottom line

We are seeing evidence that the market is rotating, rather than outright selling, when we get profit-taking sessions driven by tech selling. General market breadth has remained quite supportive, as evidenced by advancers outpacing decliners at a healthy clip on these days.

While tech selling will make a dent in the headline index level, this is purely a function of the weighting within the index.

But beneath the surface, that rotation is still providing gains at the sector level. And because we have seen other sectors outside tech put up healthy returns in the wake of previous tech-driven profit-taking sessions, we remain encouraged that the market can tread water at the index level, while generating gains in other segments of the market beneath the surface should we see tech leadership starting to cool.

As you’ve heard us say repeatedly, rotations are the lifeblood of a bull market. Based on what we have seen so far, tech-led selling proceeds have been redeployed in other sectors of the market. Investors are not redeeming out of the market and into cash. This is what the bulls would like to see.