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Investors Double Down on Tech in Rocky Quarter for Stocks

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Investors Double Down on Tech in Rocky Quarter for Stocks

The tech-heavy Nasdaq Composite thrived in a tumultuous quarter for stocks as investors parsed trade tensions, political uncertainty and signs of slowing momentum

Investors increasingly worry that a market whose gains have been heavily dependent on tech stocks could reverse sharply in the second half.
Investors increasingly worry that a market whose gains have been heavily dependent on tech stocks could reverse sharply in the second half. PHOTO: GETTY IMAGES

The Nasdaq Composite Index overcame an early slump in the second quarter and is on course to book its eighth straight quarter of gains, as fears of a trade war stifling global growth pushed investors to dump industrial stalwarts and increase their bets on shares of large technology companies.

The tech-heavy index thrived in a tumultuous three months for U.S. stocks, which struggled to gain ground as investors were buffeted by worries about trade tensions, political uncertainty in the eurozone and signs of slowing momentum in the global economy.

The S&P 500 and the Dow Jones Industrial Average rose 2.9% and 0.5%, respectively, for the quarter through Thursday, trailing the Nasdaq’s 6.2% advance. The first two indexes remain well below their January records, while the Nasdaq notched a series of all-time highs in June.

The one-directional nature of the stock rally has left investors increasingly worried that a market whose gains have been heavily dependent on technology stocks could reverse sharply in the second half of the year.

“A lot of the investing public is piling into the same things,” said Jim Paulsen, chief market strategist at Leuthold Group, who added that the S&P 500 would be mostly flat this year without technology companies. “There’s a lot of sheep following one another.”

Tech TitansShares of technology-driven companiescontinued to dominate the stock market in thesecond quarter of 2018, racing past the S&P500’s modest gain.Source: SIX
%TwitterS&P 500Amazon.comNetflixFacebookApril ’18MayJune-100102030405060

Technology had mostly avoided the tariff turmoil for much of the quarter, including when President Donald Trump imposed steel and aluminum tariffs on the European Union, Mexico and Canada on May 31. Industrial stocks in the S&P 500 fell 1.5% that day, as shares of Boeing Co. and other multinational manufacturers posted losses, while the Nasdaq Composite suffered a modest 0.3% decline.

Trade actions have had a muted impact on tech stocks going back to 1995, according to Bank of America Merrill Lynch data that showed the sector tends to be among the best-performers in the 30 days following the announcement, implementation or the end of such a policy. But some analysts warn that the latest trade battle could play out differently considering the Trump administration’s focus on protecting U.S. intellectual property and tech’s growing prominence in the global economy.

The Nasdaq on Monday posted its biggest one-day decline since April after reports suggested the Trump administration was planning to curb foreign investment in U.S. technology firms. The tech sector’s high exposure to foreign revenue also exposes it to swings in the foreign-exchange market: Should the recent rebound in the U.S. dollar continue, that could hurt multinational companies whose goods will become more expensive to foreign buyers, and overseas revenue will be worth less when converted back into dollars.

“A lot of technologies are borderless,” said Tony Kim, portfolio manager of the BlackRock Technology Opportunities Fund, who said the threat of protectionist policies against China is one of the bigger perceived risks for investors right now. “Tech needs to be in a stable environment, and this would inject a sense of instability.”

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Any stumbles in tech-stock prices could raise the risk of market contagion and wreak havoc on portfolios.

Tech’s growing dominance has skewed the broader S&P 500 away from so-called defensive stocks—sectors such as utilities, consumer staples and health care—that investors have traditionally gravitated toward during bouts of market volatility. That has left some analysts concerned that investors in index-tracking funds could be dangerously exposed to a pullback.

The degree of defensiveness within the S&P 500, which Leuthold Group calculated by using the percentage of the index’s market capitalization comprised of defensive sectors, has fallen nearly 60% from 1991 through early June, according to the group’s data. That has increased the weighting of highflying growth stocks within the S&P 500, reducing its overall effectiveness as a diversified portfolio for investors who opt to passively track the broad index, Mr. Paulsen said.

The S&P 500 is “not the same index it was when your father bought it,” he added.

Yet some analysts worry that, with uncertainty swirling over whether the U.S. will ratchet up trade tensions with China, the European Union and others, investors have mispriced the risk that the tech sector faces.

Technology companies in the S&P 500 have the highest share of overseas revenue of the broad index’s 11 sectors, with a foreign-exposure level of about 59%, according to FactSet and BofA Merrill Lynch data. That is greater than the broader S&P 500, which gets about one-third of its revenue from overseas and indirect exposure via commodities, the bank added.

Porous DefenseThe level of defensiveness within the S&P500 has fallen since the 1990s.Source: The Leuthold GroupNote: Defensiveness within the S&P 500 is measuredby the percent of market capitalization comprised bytraditional defensive sectors.
%1990’952000’05’10’151015202530354045

Still, some investors have been viewing tech stocks as a safety play, betting that companies that have produced double-digit percentage gains this year will be able to continue growing earnings even under more restrictive global trade conditions.Amazon.com Inc.’sAMZN -0.10% quarterly profit topped $1 billion for the first time in the most recent quarter, whileFacebook Inc.’s FB -0.97%earnings soared even after its user-data crisis and Microsoft Corp. MSFT -0.02% posted double-digit growth in profit and revenue.

“Long term, it looks like a legit growth story,” said Paul Christopher, head of global market strategy for Wells Fargo Investment Institute.

Even as investors say technology firms as a whole appear to be on more stable footing than they were at the height of the dot-com era in 2000, many remain cautious, citing the tendency for the stock market to contract when it is led by just a handful of outperformers.

Winning StreakThe tech-heavy Nasdaq Composite hasoutperformed the S&P 500 every quartersince the end of 2016.Quarterly performanceSource: FactSetNote: Data for 2nd-quarter 2018 is through Thursday.
%Nasdaq CompositeS&P 5002015’16’17’18-10-5051015

“Whenever the market narrows like this and everyone wants to own the same stocks like the [FAANG—Facebook, Amazon, Apple Inc.,AAPL -0.21% Netflix Inc.NFLX -1.01% and AlphabetInc. GOOGL 0.21% ] stocks, there is a feeding frenzy that can go on for a while,” said Mike Balkin, a portfolio manager at William Blair. “When it ends, it usually doesn’t end well.”

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