Volatility and the Tech Leadership Dip

After a rough patch in markets, Friday’s market returns brought a timely reminder: Volatility cuts both ways. Up and down. Here is another reminder: Volatility often brings sudden, short-lived leadership changes, which market lingo calls countertrends. They often come and go as quickly as the broader ups and downs. Extrapolating any of it forward is perilous, in our view.

We point this out because stocks’ pullback—which amounts to a -4.2% global slide from July 16 through Thursday’s close—isn’t the biggest story about this volatile stretch.^[i] That would be Tech, down -9.8% globally since its last high on July 10, also through Thursday’s close.^[ii] Its underperformance, coupled with value stocks’ newfound leadership, has spurred a cacophony of leadership shift talk. Overstretched Tech and Tech-like stocks are done, the chorus says, while the prospect of looser fiscal policy and maybe even lower rates give value the baton.

In our view, it all smacks of reading too much into short-term market movement and seeking a fundamental cause where little exists. Folks did this with Utilities earlier in the year, and it didn’t really work out.

That period shares something critical with the present: It paired a stock market pullback with a sector countertrend. This is actually pretty darned normal. When sentiment-fueled volatility hits, it manifests in multiple ways. There is the market downturn, yes. But there can also be sector or category effects.

If sentiment turns on stocks, it often naturally turns hardest on the areas that were leading. That is where the so-called “profit-taking” (a rather meaningless term that assumes you don’t reinvest the money) will concentrate. And as a general rule, the category that leads in an up market tends to get hit hardest in pullbacks and corrections (short, sharp, sentiment-fueled drops of -10% to -20%). It is all part of the sentiment reset such moves constitute.

In the spring, when Utilities shone briefly, stocks pulled back as the world digested the higher perceived probability of outright conflict between Iran and Israel in the Middle East. Traditionally defensive categories including Utilities and the old Telecom sector (now an industry within Communication Services) held up better, as they usually do when fear gets tight. Fed rate cut chatter also escalated at this time, boosting rate-sensitive areas—including Utilities. In time, the market resumed rising, and the bull market’s broader sector trends reasserted themselves.

We suspect this latest countertrend will also pass as bad volatility gives way to more of the good volatility. Whether Friday was the start, it is impossible to know. But all this stuff tends to begin and end without warning, often when people least expect it.

That goes for corrections and pullbacks, and we think it also goes for sector leadership. Yes, rotations happen mid-bull market. But they usually act more like dimmers than on/off switches. They happen in fits and starts, gaining some ground and then giving some of it back. This tends to happen to little notice or fanfare. You generally don’t get endless headlines shouting about a leadership rotation as one actually unfolds—too gradual, too sneaky. The last 10 days? Nowhere near gradual or sneaky enough, and far too much attention. Stocks are efficient and will price leadership rotation talk quickly … and if experience teaches us anything, it is that stocks will likely do something different than everyone suggests.

Also, we have seen this movie before. Exhibit 1 shows MSCI World Index returns and the Tech sector’s relative returns since the long global bull market began on March 9, 2009. When the yellow line is rising, Tech is outperforming. This long stretch includes some interesting times. Its first few years featured value leadership, then Tech had a strong run early in the 2010s before disappointing again on a relative basis through mid-decade. At that point, you will see Tech began to lead in earnest. During periods of Tech leadership, the sector’s relative returns more often fall with the market when declines come. Pullbacks and countertrends, hand in hand.

The short bear market that accompanied 2020’s initial lockdowns is an outlier, of course. What was bad for the broad market (lockdowns) was pretty ok for Tech, with many of its software companies benefiting from home working and home shopping. But then Tech underperformed during the 2022 bear market, which we think was a sentiment reaction to a host of fears (e.g., the war in Ukraine, hot inflation, spiking oil prices, rate hikes and more). And during this bull market, which began in October 2022, Tech’s relative return trends have ebbed and flowed in tandem with global stocks’ swings.

Exhibit 1: Tech’s Evolving Relationship With the Broad Market

Source: FactSet, as of 7/26/2024. MSCI World Index and Information Technology sector returns with net dividends, 3/9/2009 – 7/25/2024. MSCI World Index returns indexed to 100 at 3/9/2009. Tech relative returns indexed to 1 at 3/9/2009.

In light of this, we think it would be too hasty and myopic to presume a lasting leadership rotation has suddenly arrived. The recent history of volatility and countertrends points more to the past 10 days being simple, normal wiggles.

At some point, value will have its time in the sun. And at some point, Tech and Tech-like stocks won’t lead the pack. But this shift will probably happen in messier fashion, when few anticipate it. And even then, value leading doesn’t automatically mean Tech suffering. In a bull market, it would likely mean Tech and growth stocks in general rising, with value rising more. Probably with a lot of give and take to fool the masses, which seems to be the market’s second-favorite pastime … after delivering long-term growth.