Sunday, June 11, 2017

Tech Rotation

To close out the week we saw many of the major leading names get pounded along with any other tech stock you can think of. The NASDAQ Composite declined -1.8%, while the QQQ and XLK ETF’s dropped -2.5%.

What is astonishing despite this carnage is that the SP500 finished the day unchanged and the Dow Jones was up nearly ½ a percent! Normally if the market was set for a broad correction, when the leading index completely falls out of bed the other Indices follow suit and decline even more.

However, Friday was a day marked by textbook market rotation. Hardly any other sectors were phased by the slaughter that went on in Technology. In fact, Financials, Industrials, Health Care, and Materials all rallied fairly substantially. 

We've been waiting for the extended Tech sector to cool-off and it seems that time may have arrived. This doesn’t mean sell everything indiscriminately, but it is prudent to reduce exposure to the prior large winning positions we have held for some time now. 

I want to discuss what it means to watch price behavior for adverse “changes” to a prevailing trend. When a trend has been tremendously strong (at least on an intermediate basis) it pays to stick with that trend through normal retracements as long as the behavior of the price action is within a “normal” character. Let’s look at the Financials (Regional Banks-KRE) for a recent example of what this means. 

In November price made what appeared to be a major bullish shift in momentum by breaking out of a multi-month range. We then saw a sharp rally for 6-weeks which consolidated orderly with no real shocks to the prevailing trend. Consolidations after rallies can have little shakeout attempts (as seen in the middle of January) but follow-through is important to watch for in the following week or two. Price held the initial dip and then resumed normally to new highs.

It wasn’t until the gap higher rally that then saw a shocking reversal the following day that participants began to be alerted to a potential change in character. It is one thing for a consolidation to provide a one day shakeout, it is another to see a very bullish indication (gap higher from a consolidation) immediately sold and reversed so strongly, which occurred on March 2nd.

The ensuing action the next week or two provided zero sign of recovery, price continued to drift lower and all rally attempts were faded quickly. This is the follow-through confirmation we look for.

Clearly something had changed in the behavior after the Outside reversal from new highs, shares were then being distributed on any strength rather than accumulated in an orderly consolidation.

Seeing no relief during this time the bottom finally gave way mid-March with a selling day that has defined the market action since. There was a bit of a pop at the end of March but for all intents and purposes, price has been contained in a volatile sideways trend bounded by the March 21st range since.

Turning to the Tech sector, it is possible we may be seeing that initial shock to the prevailing, extended trend. 

The Nasdaq 100 (QQQ) has been red-hot since the January breakout

It should be noted there have been two one-day shakeout attempts since the January breakout began, one in mid-March and another mid-May. Note that neither saw a single day’s worth of follow-through.

One key item that seems different to me with Friday’s reversal is the sheer width of intraday trading range. While the other two attempts to break trend were relatively wide, Friday’s range was roughly double those prior days.  

Obviously the most important factor will be watching how price now reacts over the next couple weeks. If there is no problem and this too was just another shakeout attempt, we should see price stabilize quickly and recover. What Tech bulls don’t want to see however would be action similar to the Financials in mid-March; they don’t want to see Friday’s low taken out on a closing basis and certainly don’t want to see any rally attempt sold into strength.

Bottom line the trend remains intact for now as no lower lows were made, price is above its 50 Day and 20 Week SMA’s. But evidence is beginning to mount that suggests Tech may be due for an extended rest over the coming summer doldrums ahead.