Large-Cap Tech Stocks May Be Running Too Fast
byOct 18th 2010 11:30AM
Since the March 2009 lows, large-cap technology shares have been among the market's best performers. Propelled by heavily weighted Apple (AAPL), among others, the Nasdaq 100 ($NDX) has doubled over the past year-and-a-half, and it has tacked on nearly 20% during the past six weeks alone. That has pushed the index to near three-year highs.
The obvious question, of course, is what happens next? Will the recent momentum feed on itself, or has this breathtaking bull run set the stage for a correction of some sort? While nobody knows for sure, a number of technical and sentiment indicators are suggesting now is the time for caution.
First, as the following chart shows, the NDX has entered a band of strong resistance marked by the 2007 highs. At the same time, the index is now in "overbought" territory -- as evidenced by the latest readings on 14-day Relative Strength Index (RSI), a measure of price momentum. And the NDX is tracing out a potential negative divergence, where price and momentum are temporarily out of sync.
Indeed, a post at Market Time lends some credence to this latter view. Based on an analysis using the McClellan group of oscillators, which attempt to gauge market breadth, the blog notes that the "price oscillator is lagging the volume oscillator. This...can be seen as a few rising on big volume while the rest are neutral at best. If...correct, then we, at this moment, have a somewhat narrow index. That is not a healthy situation."
But the technicals aren't the only cause for concern. Various indicators also paint a picture of a market that's being driven higher by small investors and large leveraged speculators. As I argued in a recent post at The Big Picture, the "smart money" is making a big bet against the NDX.
Based on recent data from the Commodity Futures Trading Commission, commercial traders (i.e., defined by the CFTC as those who manage their business risks by hedging in futures and options) now have their biggest net-short position in NASDAQ-100 futures in recent memory.
As the following chart (courtesy of SentimenTrader) shows, the "smart money's" track record when it comes to identifying tradeable short-term trend reversals is not too shabby.
Combine that with the fact that many hedge funds have major exposure to technology darlings like Google, Microsoft, and Apple - according to Goldman Sachs, the latter is a top 10 holding of 75 funds - and one could argue that you have the makings for a nice little rout.
On the flipside, a post at Trader's Narrative notes that investors in the Rydex|SGI family of mutual funds, which allows individual investors to place directional bets on various indexes and sectors, have positions in the bullish and bearish Nasdaq 100 index funds that are heavily skewed to the upside. If recent history is any guide, that lopsided positioning is not a positive sign.
Other sentiment measures tell a similar story. In a post at Phil's Favorites, blogger Chris Kimble notes that the pattern being traced out in the CBOE Nasdaq Volatility Index ($VXN), which is essentially a measure of relative demand for options that can help identify optimistic and pessimistic extremes, is similar to those that preceded prior sell-offs in the technology bellwether.
And finally, another sign that sentiment toward big-cap technology may be nearing a peak is the almost fanatical interest in the NDX's biggest constituent, Apple, which accounts for more than 20% of the index. As I suggested in a post at Financial Armageddon, one recent development seems to represent the kind of extreme you see at a trend reversal peak.
As a long-time market-watcher and died-in-the-wool contrarian, I can't help but think that a newsletter targeted to investors in one popular and high-flying technology company, marketed in a post-cum-advertisement at the Business Insider ... can be seen as anything other than a sign of a top -- for the stock, the technology sector, or even the market as a whole.
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Still, the fact that technical and sentiment indicators are flashing red after prices have had an exceptionally strong run doesn't necessarily mean that the large-cap technology sector won't continue to shine. Indeed, it's possible that momentum alone might allow the rally to continue for some time to come.
But for those who believe that history has a way of repeating itself, it's probably time to adopt a more conservative stance.