Watch the Sector Rotation
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This week’s selloff brought with it a broader rotation out of Technology and into Energy, Consumer Staples, and Healthcare sectors. The first is due to natural gas, and the second and third are due to a defensive shift. Staples and Healthcare tend to outperform in risk-off environments.
The healthcare sector also benefited from recent strong earnings results, acquisition announcements, and easing of political uncertainty around drug pricing. For example, deals were struck with Eli Lilly (LLY) allowing them to sell obesity drugs to Medicare/Medicaid patients. A huge boon to LLY’s market potential while maintaining profitability.
What has been failing spectacularly are Consumer Discretionary stocks like restaurants, hotels, airlines, and retail. Many of these companies reported weak Q3 earnings as consumers retrench. Low income consumers are trading down to more affordable options and cutting back on discretionary spending. The gap between the wealthy and low-income are widening to unsustainable levels.
Meanwhile, unprofitable tech stocks continued to sell off, as we indicated last week. This included hot theme stocks like robotics, space exploration, quantum, drones, batteries, and nuclear energy. This is typically what happens when liquidity (money supply) is removed from the financial system. We explained the phenomenon here.
In particular, companies that make memory chips and storage systems finally broke down after a torrid multi-month rally. For example, Sandisk (SNDK) was up 10x from their April lows! When tech stocks go parabolic like this, the downside is often equally as dramatic, especially if triggered by a negative catalyst:
The good news is the rotation may be coming to an end. Many of these junk tech stocks are down 40%-50% from recent highs. For example, Rigetti Computing (RGTI), a hot quantum stock, is down -59%. Oklo (OKLO), a nuclear reactor developer, is down -52% from highs made in October.
Even though the major indices began pulling back about 12 days ago, individual tech stocks have been pulling back for several weeks. So by the time we saw big drops in SPX and QQQ, the wipeout was nearly over and beaten-down stocks are mounting big reversals.
Through all of this, Mag 7 dropped less than unprofitable tech. This jibes with the “flight to safety” dynamic wherein investors seek out high-quality, defensive companies. But a selloff in junk tech is not a cause for a sustained broad market selloff. We could see the rally resume if there’s a broadening out to cyclical sectors like Industrials, Financials, Consumer Discretionary, and small caps.
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