For some context on the unprecedented dominance of the tech sector on the overall market, here is some perspective from BofA’s Savita Subramanian on October returns, when Tech continued to lead the other ten sectors, generating +7.8% on a total return basis. This translates into a whopping 75% of the S&P 500’s return last month!
Furthermore, with virtually every lagging hedge fund rushing to buy the tech sector, chasing such activist central banks as the SNB, the sector’s 24.5% weight in the S&P 500 is now the highest since October 2000.
That said, considering tech companies reported some of the strongest 3Q earnings results, the best revision trends, and rank at the top of BofA’s quant model, is there anything to be concerned about?
According to BofA, the biggest risk is the extreme crowding and positioning by fund managers. As Subramanian expains: “we hear frequently from clients, ‘you don’t want to sell Tech until year end.’ And funds certainly reflect this sentiment: Tech is the most overweighted sector by large cap active managers, displacing Discretionary whose relative weight dropped for the sixth consecutive month.” As noted above, the recent Tech rally means the sector now represents 24% of the S&P 500 index – a post-tech bubble high – and a remarkable 30% of all active fund holdings today, the highest levels in BofA data history since 2008 (Chart 1).
What about other sectors: in addition to Tech, Utilities (+3.9%), Materials (+3.9%), and Financials (+2.9%) outperformed last month. Laggards were generally defensive: Telecom (-7.6%), Staples (-1.4%) and Health Care (-0.8%) underperformed the most, while Energy (-0.7%) was also in the red despite the rally in oil prices.
YTD, Tech maintains its dramatic lead (+37.2%), contributing just under half of the S&P 500’s 16.9% total return, followed by Materials (+20.3%) and Health Care (+19.4%). Telecom (-11.9%) and Energy (-7.2%) remain in the red.
To be sure, the impact of tech on underlying financial metrics is also staggering, as the following charts from Credit Suisse show: with tech, EBITDA margins are near all time high. Ex tech, they are roughly 3% lower and in secular decline, courtesy of high barriers to entry.
The next chart shows that while tech holds the highest share of S&P market cap, it is also the fastest growing sector.
And while the massive crowding in the tech sector is a red flag for Bank of America, for Credit Suisse this is perfectly normal, and in a report released today, its analyst Andrew Garthwaite writes that “many clients cite data indicating that just a handful of stocks (largely tech) account for almost half of returns. However, we don’t find such analysis to be particularly informative; such dynamics are far from unusual – in fact, it is often the case that a small number of stocks account for an outsized share of market gains, as shown in the chart below.”
Of course, it is also that same small number of stocks that gets hammered once the tide reverses. For now, however, with vol at all time lows, traders have yet to express any concerns that the tremendous tech rally of 2017 is in dangers of ending. Ironically, the single biggest threat to the US tech sector may be the US government itself, which is starting to realize that it is leaving just a little too many pounds of flesh on the table…
— Matt Stoller (@matthewstoller) November 6, 2017
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