Don’t Hold Your Breath for Big Tech
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Wall Street’s pain trade keeps on trucking.
After the June CPI green-lit the Federal Reserve to finally cut interest rates, popular investor positioning has been turned upside down.
A wicked reversion trade was set in motion… vaulting small caps to their highest level in over two years.
That rebirth in the cyclical trade came at the expense of the most crowded trade of all: mega-cap tech.
In just two short weeks, the Russell 2000 surged 8.35% while the tech-heavy Nasdaq Composite dropped 7.86%… a stunning change of fortune.
At TradeSmith, we’ve been vocal on why you need to be on the right side of this equalizing money shift. Our historical studies show that small-caps are primed for market-beating gains in the months ahead.
We’re not changing our tune. The wind is in the small-cap sails right now.
But today, instead of focusing on the winning side of the trade, we’ll look for answers on the other side of the equation… mega-cap tech.
Last Tuesday, the popular Nasdaq 100 made waves with its single-largest daily decline since October 2022.
You might be itching to buy the dip, looking at the past year and a half of mega-cap dominance. Before you do, take a minute to read today’s TradeSmith Daily… because one study suggests buying the big-tech dip today is a mega blunder.
But before we dive into that data-rich analysis, let’s unpack the current state of popular growth stocks…
The Fall of the Magnificent 7
The sheer magnitude of the rotation is eye-popping. Below you’ll see how decoupled small caps are from the Nasdaq.
Since July 10, the Russell 2000 ETF (IWM) has gained 8.46% while the Nasdaq 100 ETF (QQQ) has fallen 8.89%… a mirror image of each other.
Also notable is Tuesday’s 3.65% plunge in the QQQ, which I’ve shaded in red:
Lasering in on the Nasdaq, we know the setback is due to its heavy allocation to a handful of stocks called the Magnificent 6 (formerly 7, before TSLA’s 2024 performance kicked it out of the club).
At last measure, the QQQ had 40% of its assets tied up in these six behemoths:
- Apple (AAPL) representing 8.9%
- Microsoft (MSFT) at 8.53%
- Nvidia (NVDA) at 7.78%
- Alphabet (GOOGL and GOOG) equaling 5.41%
- Amazon (AMZN) at 5%
- Meta Platforms (META) at 4.4%
This is a staggering concentration. And all of these names, minus Apple, have fallen the past month, which you can see below (disclosure, I own MSFT, GOOGL, GOOG, and META):
Wherever these market horses go, the index follows. They are a main reason for the vicious 3.65% plunge in the Nasdaq last Tuesday.
And what’s important about that day can be best explained through the lens of historical data…
What Comes After a Mega-Tech Selloff
Anytime a quake of this scale hits a group of stocks, it’s worth investigating. The Nasdaq falling nearly 4% made the cut.
While trawling through data, I found that since 1986, the Nasdaq100 has fallen 3.5% or more just 231 times.
That averages out to just over six times a year. So this is a relatively rare event… but common enough to give us plenty of data to analyze.
Now, here’s what surprised me about those selloffs…
You might expect big tech drawdowns are a great opportunity to buy the dip. But when you plot the forward returns, you’ll notice the lackluster performance in the months ahead.
Whenever the QQQ falls at least 3.5% in a day, the index:
- Jumps 1.1% a month later…
- Climbs 2.1% three months later…
- Lifts only 4% six months out …
Looking out further, and we see 12-month returns that keep pace with the market… and two-year returns of over 21%.
Understand that this data is broadly skewed by the dot-com crash, where the Nasdaq 100 suffered frequent big drops and tech stocks were dead money for years afterward.
Regardless, this data tells me large-tech selloffs can forecast choppiness in the near-to-medium term.
Am I telling you to go and sell all your mega-cap tech? No.
What this signal suggests is a digestion period likely ahead, with some healthy bobbing and weaving.
If you’re looking to go shopping for beaten-down, large-cap tech… take your time. Odds are you’ll get a better price.
And this data reinforces the theme we’ve been all over at TradeSmith Daily… having a larger allocation to smaller, unloved areas as the market equalizes.
Add in the fact that the Trump Trade favors small caps… and one massive thrust signal does too.
That’s the better near-term opportunity.
New leadership is taking hold. And it’s being funded by profit-taking in tech stocks.
Now’s the time to ride the small-cap train. Especially areas like Financials, REITs, Consumer Discretionary, and Industrials.
Regards,
Lucas Downey
Contributing Editor, TradeSmith Daily