Can Tech Stocks Stop the Rot?

By Han Tan, Market Analyst at FXTM,

US equities are set to fall further on Friday with futures now in the red and led once more by tech stocks.

The Nasdaq Composite Index saw a 4.96 percent plunge on Thursday which was its biggest single-day decline since 11 June, while the S&P 500 dropped 3.5 percent. The selloff was likely fuelled by concerns that the tech sector’s lofty valuations may prove unsustainable triggering a wave of profit-taking, which also left a trail of carnage in the options market.

From a technical perspective, the drop was necessary and healthy as it brought the Nasdaq’s 14-day relative strength index (RSI) away from severely overbought levels. And such a move shouldn’t come as a surprise. Since the index began bouncing out of a bear market in March, it has seen a pullback whenever its RSI has hit or crossed above the 70 threshold, which denotes overbought levels. This week’s drop may have been more violent given that the Nasdaq had been allowed to gather so much froth, as the RSI even breached 80 earlier this week.

Perhaps market participants are rebalancing or simply profit-taking ahead of the Labour Day weekend. How stock markets perform once trading resumes next week may be more indicative of whether a trend is truly forming.

It remains to be seen whether the tech titans have had their time in the sun and whether the rotation into the laggard sectors like financials could leave a big dent in Big Tech’s near-term performance. Even after Thursday’s selloff, valuations remain stretched with the Nasdaq Composite Index’s P/E ratio still above 60. However, should this pullback extend into a 10 percent correction that may prove too tempting a buying opportunity for fans of Big Tech, who could then swarm back in and restore bullish momentum to the Nasdaq.

After all, the fundamental backdrop still includes major elements that are conducive for the tech sector. The Fed is willing to let the US economy run hot which is supportive overall of equities, while the ‘new normal’ ensures the world remains reliant on Big Tech even as the pandemic rages on in major economies.

It’s also important to note the looming potential catalysts. A US non-farm payrolls report that reads better than the expected 1.35 million print could stop the bears in their tracks today, prompting the resumption of equity gains. Focus will then turn to the next round of US fiscal stimulus, which if approved by the Senate that reconvenes next week could also reignite tailwinds in benchmark US indices.