Market Note
Technology- Not Looking Good !
March 22, 2018

The technology sector has been a great investment over the last few years, no doubt about it. Not only has the technology sector produced large returns for investors, but it is also been one of the major focuses of the media. With constant stories in the media of how companies like Google are taking over the world, investors have felt comfortable investing in the technology sector.

It is not just the technology sector that has performed well over last few years, many other sectors of the US stock market and the stock market itself have performed well. One of the better ways to evaluate sector’s performance isn’t necessarily on an absolute basis, but on a relative basis. Investors have a choice of whether to invest in different sectors of the market, or even the market itself. From an investor’s standpoint, if you are investing in a sector of the stock market, it is the relative performance of the sector versus the market that is generally important. Of course, there are other considerations, such as risk levels for different sectors, etc. Nevertheless, relative performance compared to the market is an important consideration. Investors generally want to own sectors that are outperforming the stock market.

The technology sector has strongly outperformed the S&P 500 since mid-2013 (see graph below). Its outperformance can be broken down into two stages. The first stage starts in mid-2013 and ends in late 2016. The second stage starts when the first stage finishes and continues into 2018. The difference between the two stages is the slope of trajectory of each stage. The second stage has a trajectory slope that is much steeper than the first stage as the technology sector outperforms the S&P 500 at a greater rate compared to the first stage. Stage 2 represents an increasing interest in the technology sector by investors. For good reason, as big technology companies have produce solid results over the last few years.

One perspective of investing in the technology sector at this time is that if there is a pullback in the sector, it will be temporary and due to strong fundamentals, the sector could be expected to outperform the S&P 500 over long-term. There is nothing wrong with this viewpoint. What I am putting forth at this time is the position that technology sector is overvalued on a technical basis relative to the S&P 500 and has an increased probability of underperforming the S&P 500 and even producing negative returns in the short term. In other words, based upon the technicals, it is not a good time to enter into an increased position in the technology sector. To make matters even less favorable, the technology sector is currently not in its seasonally strong period, when it typically performs well.

 2018 03 22 XLK SP500

In the diagram above, when the relative performance of the technology sector versus the S&P 500 touches the top of its trading channel (dotted blue vertical lines), the technology sector has generally underperformed the S&P 500 over the next few months. This occurred in stage 1 from 2013 to 2016, and stage 2 from 2016 to 2018. In the second stage, when the technology sector was outperforming the S&P 500 at a greater rate compared to the first stage, the technology sector started to underperform much more quickly after it touched the top of its trading channel, compared to the first stage.

Where do we stand now? The technology sector has once again touched the top of the trading channel and has started to turn down. The debacle with Facebook and data breaches obviously has not helped the technology sector and can be partly blamed on pushing sector lower, but it is probably not the whole story. If the previous trend of the technology sector underperforming the S&P 500 once it touches the top of its trading channel, holds true, it can be expected that the technology sector will probably show further weakness.

Of course, the technology sector could break above the trading channel and start an even steeper stage of outperformance relative to the S&P 500. To make this assumption, an investor would have to be ultra-ultra bullish on the technology sector. Given that the technology sector is not in its strong seasonal period and has a weak relative strength technical profile compared to the S&P 500, there is a strong argument to fade the technology sector at this time.