U.S. Stocks: Storm Clouds Gathering as Tech Sector Enters Correction

July was a stellar month for Wall Street’s major indexes, as positive earnings surprises and pro-growth optimism propelled the S&P 500 Index to its highest levels since January. But a closer look at sector rotations and the recent performance of Corporate America’s most popular bets paint a very murky picture of what’s to come.

Correction Ahead? It’s Already Here

U.S. stocks are showing signs of “exhaustion” and could be headed for a major meltdown in the not-too-distant future, according to analysts at Morgan Stanley. In a note to clients that was published on Tuesday, Stanley warned that sectors tied to technology, consumer discretionary and small caps face the greatest risk.

“With Amazon’s strong quarter out of the way, and a very strong 2Q GDP number on the tape, investors were finally faced with the proverbial question of ’what do I have to look forward to now?’ The selling started slowly, built steadily, and left the biggest winners of the year down the most. The bottom line for us is that we think the selling has just begun and this correction will be biggest since the one we experienced in February,” the bank said in its note.

In market speak, a correction is characterized as a fall of at least 10% from a recent high. Crashes that lead to bear markets are observed when a stock, commodity or index falls 20% or more from its latest peak.

Using the above criteria, roughly 40% of the S&P 500’s information technology index is already in correction territory. Stocks like Facebook (FB) and Netflix (NFLX) – members of the prestigious FAANG category – have declined by at least 20% from their recent high. The broader Fang+ index, which also includes Twitter (TWTR), Nvidia (NVDA), Tesla (TSLA), Alibaba Group (BABA) and Baidu (BIDU), has also fallen into correction territory.

Facebook recently made history by shedding $119 billion in market cap in a single day of trade – the most on record – following a disastrous earnings call that raised doubts about the social media giant’s moneymaking prowess. Share prices have yet to make a meaningful recovery.

Growth vs. Value

With Morgan Stanley warning of “a rolling bear market” in the future, a researcher at Nomura Holdings just uncovered the biggest rotation from growth stocks to value stocks since the 2008 financial crisis.

Charlie McElligott, an executive with Nomura’s cross-asset strategy unit, said the rotation occurred over a three-day span, which revealed a standard deviation of 4.3 in the ‘Value/Growth’ ratio relative to ten-year returns. Basically, this means investors have diverted large swathes of capital from growth stocks to assets with lower prices relative to their fundamentals.

On Wall Street, growth stocks are associated with high-quality, successful companies whose earnings are expected to continue outpacing the market. Companies in this category usually have high price-to-earnings (P/E) ratios and high price-to-book (P/B) ratios.

Value stocks, on the other hand, have low current P/E ratios and low P/B ratios. Investors buy into value stocks on hope that the company will increase in value once the broader market recognizes its potential.

If this trend continues, it likely means that portfolio managers are shifting into a defensive posture through a traditional value investing. approach This would mark a significant departure from the high-flying bull market, which emphasized growth picks.

To be sure, not everybody agrees that were are seeing a rotation from growth to value. Other analysts contend that the recent shift is about selling winners following the record surge in tech shares. That said, investors should expect more volatile swings in equities post-earnings season.

Featured image courtesy of Shutterstock. 

Chief Editor to Hacked.com and Contributor to CCN.com, Sam Bourgi has spent the past nine years focused on economics, markets and cryptocurrencies. His work has been featured in and cited by some of the world's leading newscasts, including Barron's, CBOE and Forbes. Avid crypto watchers and those with a libertarian persuasion can follow him on twitter at @hsbourgi