Tech stocks are crushing the market this year, but there are signs the sector’s out-performance may be coming to an end, according to financial newsletter The Bear Traps Report.
The Nasdaq 100 index is up 15 percent year-to-date through Monday versus the S&P 500’s 8.5 percent return.
Larry McDonald, the author of the report, pointed to an important sign: the difference in the volatility measures for the Nasdaq 100 and the S&P 500 has hit its widest level in over a decade. The two measures are due to revert back to more normal levels, the strategist said in a note to clients.
The CBOE Volatility Index, or VIX, is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices, according to the CBOE. While the CBOE Nasdaq 100 Volatility index, or VXN, does the same for the Nasdaq 100 index.
“You have to go back to 2004 to find this large a volatility premium” between the Nasdaq 100 VXN over the S&P 500 VIX, McDonald wrote in the Bear Traps Report. The “volatility premium is spectacular.”
These measures of volatility represent how much traders are paying to hedge against downside moves for the respective indexes. As expectations for volatility rise, it gets more expensive to buy insurance against a potential fall. The Nasdaq 100 and S&P 500 volatility measures differ by 7.5 as of July 3.
The strategist shared his key reasons why Nasdaq volatility levels are rising versus S&P 500 and why it may foreshadow a tech sell-off in an email.
He noted that investors are rotating to value stocks and away from growth stocks. “As we start Q3, growth continues to lose leadership,” he also said in his report.
During the first half of this year, 41 stocks in the Nasdaq 100 rose 30 percent or more. Further, he said in the email, there was a connection between bond prices and the rise in the Nasdaq 100, and now they are going down together. His conclusion: “Valuations are insane” in the Nasdaq 100.
McDonald warned his clients that technology may under perform in the coming months and recommended investors trade ahead of the potential decline.
“Getting out in front of the rotation is more important than valuation – as capital flows out of highly concentrated trades it has to go somewhere in a bull market. It’s a growth into value tsunami,” he wrote.