Today’s big news was “the great rotation“. Tech stocks (and particularly FAANG) got crushed while finance and energy rallied. Previously, tech stocks were soaring while the energy and financial sectors fell.
There’s been a lot of speculation going on about what this means for the broad U.S. stock market (S&P 500). Instead of speculating, let’s look at the historical data.
What happens when XLK (tech sector ETF) closes down more than -2.4% while the Dow Jones is positive.
*We’re only looking at cases after the dot-com bubble. During the 1990s, tech would frequently soar while large cap fell (and vice versa). Back then people believed in the “new economy” Kool-aid. The “rationale” was that “what is good for tech must be bad for large cap old-economy companies, and vice versa”.
*We’re only using the CLOSE $.
*You can use NASDAQ instead of XLK, but XLK is more focused on tech. NASDAQ isn’t purely tech stocks.
We encountered a problem in this study.
This is extremely rare.
- Large cap Dow and tech never diverged this much during the current bull market or the 2003-2007 bull markets.
- Even when Dow (i.e. non-tech) and tech diverged, it was usually “Dow fell, but tech fell much more”. The market rarely saw the Dow rise while tech fell significantly.
- When the bull market resumed after the Russian 1998 financial crisis, this signal only came out once: April 14, 1999.
- The other times this signal came out were just before or during the 2000-2002 bear market.
*Sentimentrader did a similar study to ours. Their result was much more bearish. See the results here.
April 14, 1999
This is the only case that’s comparable to today. The S&P was in the middle of making a pullback. Then it made a new high, and one month later started a 7.1% “small correction” (mid-May 1999).
January 6, 2000
This was the first leg of the S&P’s 10.3% small correction.
When this correction ended, the S&P jumped to a new high in March and that was the end of the bull market.
The 2000-2002 bear market cases
The Dow and tech sector frequently diverged during the bear market. Sometimes this divergence was followed by a stock market decline and sometimes it was followed by a rally. There was no pattern.
These cases aren’t comparable to today because we are in a bull market.
It’s hard to draw inferences from 2 cases, especially since both of those cases were from more than 17 years ago.
What does this mean for the S&P 500 today? Who knows. The point is, don’t read too much into tech’s selloff today.
The S&P can make a 6%+ “small correction” at any time, with or without the tech sector’s decline. This “small rally” in the S&P 500 is simply too aged. Click here to see why.