Thackray Market Note
Technology- Market leader could lead stock market lower in June
June 2, 2017

There is a fairly good chance that we are somewhere close to the top of the stock market as we have been in one of the longest expansion periods, albeit one of the slowest. This is not to say that a correction is imminent, but rather a comment of where we are in the stock market cycle. The U.S. Federal Reserve has artificially engineered this protracted slow economic expansion, but at some point it will end. Historically, their has been a progression of which sectors in the stock market perform better at different points in in the stock market cycle, which tends to lead the economic cycle.

In 1995, "Sam Stovall published Sector Investing: How to Buy The Right Stock in The Right Industry at the Right Time."   The chart below is an extract from his book and is posted on stockcharts.com. It outlines the general consensus at the time of which sectors performed well at different times in the business cycle. Traditionally, it has been the defensive sectors that have outperformed during the contraction phase, cyclical and technology sectors in the trough phase, industrials in the expansion phase, and basic materials and energy in the topping phase. In the 1990's, many investment managers used a rotation strategy based upon this stock market model.


Historically, it was the resource sectors that outperformed in the topping process of the stock market cycle, as economic growth pushed up the demand for materials, raising commodity prices and pushing up inflation. As a result, central banks would raise their interest rates to control inflation, with the result very often being an economy that was put into a recession.

The 1999/2000 stock market top was different as the technology sector led the stock market higher.


Since the late 1990's, the order of which sectors have outperformed at different points in the stock market cycle has changed. In the 1990's, the technology sector was growing rapidly and increasing productivity in the economy and as a result this action led to the sector becoming a late cycle performer. In the 1990's, investors loved technology stocks. The narrative in the late 1990's, was that the world was becoming more dependent on technology and technology stocks were a "sure thing." As a result, a bubble in technology stocks developed. At the time, the U.S. Federal Reserve was increasing interest rates to try and slow the market down, but initially this did not affect technology stocks as many investors rationalized how the technology sector would not really be impacted by rising interest rates. We all know what happened with the tech bubble bursting in 2000 and bringing down the rest of the stock market.

The stock market topping process in 2007 had some similarities and also some differences compared to the late 1990's and 2000 stock market top. In the 2007 market top, both the resource and technology sectors outperformed the S&P 500. The technology sector turned down in late 2007, at the time of the market peak. The commodities and materials sector did not peak until the second quarter of 2008. Commodities and materials had been performing well and outperforming the S&P 500® since the year 2000. The sectors represented good value after the 2000 crash as they had previously underperformed for an extended period of time and remained relatively cheap. Valuation provided the base, but the general theme at the time was that the world was in a commodity super-cycle and was going to run out of “the stuff.” That world came crashing down in 2008.

 


It was interesting to note that the technology sector outperformed the S&P 500® in 2007 and led the market into its peak in late 2007. This was the second market peak in a row where technology led the stock market at the top of the cycle. Traditionally, the technology sector has not been a late market cycle performer. It is possible that in the past, pre-2000 market top, that technology was viewed as being more speculative and investors shied away from speculation at market tops. 


Today, although the technology sector is still thought of as being somewhat speculative, it is viewed as a sector with large potential gains derived from not only productivity gains but also its ability to creatively destruct industries, changing the way they operate and commanding a robust revenue stream. As a result, many investors believe that the technology sector should be owned at any cost and the sector is impervious to the market noise that surrounds it.

In the previous two market tops (and this possible market top) investors believed that they should own technology stocks at all and any costs. This phenomenon is very much like the “Nifty-Fifty” stock phenomenon in the 1970's. The Nifty-Fifty were fifty of the biggest companies trading in the 1970’s. Investors believed these stocks were "sure things" and would continue to grow forever. Their belief pushed the Nifty-Fifty into stratospheric valuations compared to the rest of the stock market. They eventually crashed.

The technology sector is once again leading the stock market and it has been outperforming the S&P 500® since 2013. The strong performance in the sector can be somewhat justified largely by stronger earnings growth than the S&P 500®. Just because the technology sector is outperforming the S&P 500® does not mean that the stock market is in a topping process, especially since the sector can outperform for many years in a row. 


The present concern is that June tends to be one of the weaker months of the year for the technology sector.


In my Thackray's 2017 Investor's Guide, I illustrate the monthly performance of the technology sector (above) which shows the sector's monthly relative performance from 1990 to 2015. On a median basis, June is the weakest month of the year and the sector has also only outperformed the S&P 500 only 38% of the time in June. It is possible that the technology sector could continue to rally through the month of June and into July, but given the sector's weaker seasonal profile in June, investors should monitor the technology sector for any weakness. If the sector were to show weakness, this could indicate trouble for the overall broad market.