Stocktake: ‘Tech wreck’ driven by algorithm traders
Apple, Amazon and Facebook had gained 30 per cent this year and needed to cool
The “tech wreck” reignited talk about the apparently outsized impact of the Faang stocks – Facebook, Amazon, Apple, Netflix (or Nvidia) and Google – on market indices. Photograph: Carlo Allegri/Reuters
As always with any sort of market retreat, the coverage was hyperbolic. Yes, the Nasdaq suffered its worst two-day fall of the year and trading was volatile. At the same time, it was hardly that severe – tech stocks merely returned to where they were trading two weeks earlier. Nor was it unexpected – Apple, Amazon and Facebook had gained some 30 per cent this year and needed to cool off. Nor did it bring down the overall market, with investors instead rotating into other rick-on sectors.
More interesting than the magnitude of the sell-off was the technical nature of it. “While fundamental narratives explaining the price action abound, the majority of equity investors today don’t buy or sell stocks based on stock-specific fundamentals,” noted JPMorgan, which estimates only about 10 per cent of trading is now done by traditional traders.
Instead, the quants have taken over, resulting in rules-based trading focused on specific factors such as momentum, growth, value and volatility. Oddly, tech stocks have been even less volatile than utilities this year. As Goldman Sachs pointed out, that has resulted in factor crowding; algorithms based on momentum, growth and low volatility were simultaneously driving up tech prices. When tech prices turned violently south, the momentum traders got out, as did the low-volatility brigade.
The quants aren’t going away. Expect technical sell-offs and rallies to become increasingly common.
Faang stocks will not take down market
Prior to the tech sell-off, the Faangs had been on fire, contributing roughly 30 per cent of the S&P 500’s year-to-date gains. That sounds extreme, and fears indices were too dependent on this small basket of stocks were seemingly confirmed when the selling took hold; indices fell even though the vast majority of stocks actually gained on the day.
However, nothing strange is going on. Last week, hedge fund AQR examined previous years and found the five top-performing stocks always had an outsized impact on index movements; the Faangs’ current influence is not abnormal.
Is it dangerous that all five stocks are from the same sector? Not really – companies from the same sector tend to be top contributors at the same time, notes AQR; in more than a third of instances, three of the five top-performing stocks were from the same sector.
Ned Davis Research data confirms AQR’s thesis. In the dotcom era, the five top-performing technology stocks were adding 1.5 percentage points to the market each month, three times greater than today.
The Faangs may lose their bite, but they’re unlikely to take indices down with them.
Fund manager survey suggests rally can run
Financial commentators seem to believe the main takeaway from Merrill Lynch’s latest monthly fund manager survey is that a record number believe global equities are overvalued. However, the key message may be that stocks actually have further room to run.
It’s true that the last time fund managers were nearly as concerned about valuation as they are now was at the height of the dotcom bubble in 1999. Back then, however, investors didn’t care; they continued buying anyway. In contrast, cash levels have actually risen over the last month and remain comfortably above historical norms, while equity allocations are in line with historical averages, indicating an absence of irrational exuberance. Sentiment aside, a “big top” would require higher yields and falling earnings; today, global profit expectations are high.
There is some exuberance in the survey though – towards Europe. European exposure is way above normal levels – 1.7 standard deviations above its long-term mean, according to Fat Pitch blogger and sentiment expert Urban Carmel, near 26-month highs.
That’s understandable – Europe’s fundamentals look strong. Still, bullish sentiment means European stocks are clearly vulnerable to any near-term setbacks, and the risks of relative underperformance are rising.
Despite a 20 per cent global stock rally over the last year, however, there’s still no sign of the “big top”.
Market timers: don’t miss Fed days
Market timers are often warned of the dangers of being out of the market. It’s a tricky business, hence the old cliche about time in the market being more important than timing the market. If you are going to try it, however, be sure you’re invested when the Federal Reserve, which hiked US rates last week, announces its policy decisions.
So-called Fed days represent just 3 per cent of all trading days. Those handful of days can make all the difference, Bespoke Investment Group noted last week – since 1994, almost a third of all market gains have occurred on Fed days.