The tech-heavy Nasdaq 100 index has produced a remarkable performance so far this year. The index took a hit earlier in the year, along with the global stock markets amid worldwide shutdowns as the coronavirus spread across the globe. However, it has since rallied over 40% from the lows to the most recent highs. It’s no secret that the technology sector has been leading the recovery in equities, but we are now seeing signs that the rally may be losing momentum.
Following a strong performance in August, the Nasdaq 100 index has seen a correction in the past week, with no clear catalyst. The Financial Times reported large purchases of derivatives in big tech names by SoftBank as a key reason for the August rally, but there are a couple of reasons that may have driven the downside move. Firstly, before the sell-off, we were seeing signals of a disconnect between the S&P 500 index, and the corresponding volatility index. This seemed to be the result of protection buying ahead of the US elections, in order to hedge against volatility. Equities eventually aligned with this move, suggesting that the downside may have been profit-taking and exposure reduction ahead of the elections. Current polling numbers indicate that the elections could be a tight one, which means that we will likely see continued volatility in equities heading into November.
Another reason behind the downside in technology stocks is likely to be rotation and portfolio re-balancing. When the stock market recovery began in April, technology companies would have been on the top of investors watchlists. As the world went into lockdown, businesses were relying on technology to continue operating, which meant that the tech sector would be one of the first to recover. Since then, we can see from the chart below that Nasdaq has posted a stunning rally. This rally will have left a lot of investors overweight on the tech sector, and as the global economy continues to recover, other sectors are now starting to look attractive again. This means that investors are likely realising profits on their tech positions and diversifying into other sectors.
Moving forward, the technology sector continue to look attractive, but the pace will likely be slower than what we have seen in recent months. In the short term, the US elections are the main risk for all equities and could provide us with a bigger correction. However, in the longer term, I will be looking at buying the dips in both the Nasdaq and S&P 500. I expect the tech sector to continue leading the current bull market, just as it did the previous one, and if we get a deeper pullback, it may even be worth looking at individual stocks. Provided that the global economic recovery remains broadly on track, there will be a long way to go with equities and so, it will be important to exercise patience in building a long term portfolio.