Tech's dominance coming to an end?

Quick recap: two weeks ago

Two weeks ago, the Kvarn Pulse newsletter was written in a fairly cautious mood.

The S&P 500 index's latest rally appeared to have stalled, and the share of stocks in an uptrend appeared to have outright collapsed.

On the other hand, the Nasdaq 100 index was still close to its highs. At the time, the technology sector appeared to be moving completely independently of the rest of the equity market.

Tech's dominance coming to an end?

Over the past two weeks, the equity market outlook has become slightly brighter at the index level. The S&P 500 index has risen to new record highs, and even after the decline of recent days, it is still at the level of its 50-day moving average.

The most significant shifts in the equity market, however, have taken place beneath the index level.

Two weeks ago, the S&P 500 index appeared to have split into two segments moving along completely different paths: the technology sector and everything else. The technology sector looked strong, while almost all other sectors were in a deep decline. We drew attention to this divergence and concluded our analysis with the following assessment:

“Our clearest expectation is that the strong divergence between these segments will close in the coming weeks.”

Two weeks later, we can note that this divergence has indeed started to close.

In our previous Pulse newsletter, we wondered whether this would happen with the technology sector following the rest of the S&P 500 lower, or the rest of the index following the technology sector higher. Right now, it appears that we have seen a combination of both.

The technology sector, which clearly led the market in September, has weakened, and the Nasdaq 100 index has fallen to around its 50-day moving average.

Within the technology sector, semiconductors in particular have fallen sharply.

Outside the technology sector, the picture looks almost like a mirror image. The ProShares S&P 500 Ex-Technology ETF (SPXT), which fell steeply in September, briefly dipped below its 200-day moving average but has rebounded sharply over the past two weeks.

Market breadth, which deteriorated sharply in August and September, has also improved clearly in the first half of October. In two weeks, the share of stocks above their 50-day moving average has grown from about 20 percent to about 35 percent.

So the technology sector, which had been leading the market, has weakened, while the other sectors that had looked weak have strengthened. What should we make of this?

One interpretation is that the market's temporary overweighting of the technology sector has now unwound and the market has returned closer to some kind of equilibrium. This is illustrated, for example, by the ratio of the technology sector (XLK) to the rest of the S&P 500 (SPXT) returning close to its 50-day moving average.

Now that the most obvious imbalance appears to have unwound, the key question is what happens next. If the equity market's upward momentum is to continue, we would expect the technology sector to soon start outperforming the rest of the index again.

On the other hand, if that does not happen and the technology sector continues to weaken in relative terms, it could be a sign that, rather than a natural “mean reversion”, investors are shifting more clearly towards a cautious stance.

We believe that the XLK/SPXT ratio and its 50-day moving average could serve as a fairly good barometer for the equity market. As long as the ratio stays above its 50-day average, a continued rise in the equity market looks like the most likely scenario. If it breaks below this level, we will have to take the possibility of a correction more seriously.

If more significant corrections were on the way, they would most likely soon show up in the VIX index as well. The VIX index has risen in recent days above its 10-, 20- and 50-day moving averages. This is a reason to watch the situation somewhat more closely.

In particular, we note that the VIX/VIX3M ratio has risen above all of its moving averages, which suggests that short-term volatility expectations are rising.

In summary, the state of the equity market still looks fairly stable, and we have not yet seen evidence that the emerging uptrend has broken. We are, however, approaching the point where a continued uptrend would start to require the technology sector to strengthen again. The coming week may tell us whether the equity market's defensive turn in recent weeks has been mere surface noise or perhaps an early warning of a more pronounced correction.

Gold consolidating

At the start of this week, the gold price showed promising signs suggesting that its downtrend might be coming to an end. However, the latest inflation figures released on Wednesday once again raised investors' expectations of future rate hikes, and the gold price, as it typically does, reacted to the news by falling.

The gold price is still below all of its moving averages. The $4,100 level has, however, served as support so far, and it remains interesting to see whether the gold price has already found its bottom.

The other precious metal, silver, is meanwhile already close to its July low. If the silver price breaks below the $55 level, we will have to prepare even more for the possibility that the gold price could also fall to even lower levels.

Crypto market following tech stocks

This autumn, cryptocurrency prices have once again moved largely in step with tech stocks. In September, crypto prices looked strong as tech stocks significantly outperformed the rest of the equity market. In the first two weeks of October, by contrast, we have started to see clear softness in cryptocurrency prices.

The price of the largest cryptocurrency, bitcoin, has so far remained fairly stable. The price is currently around its rising 50-day moving average, meaning the uptrend is still intact. Over the past week, however, we have seen the price fall below both its 10- and 20-day moving averages, and both of these averages turn lower.

For now, the slight decline in the bitcoin price looks like nothing more than a natural dip after a strong rally.

If we compare bitcoin (using the bitcoin ETF IBIT as a reference) with the S&P 500 index (using the S&P 500 ETF SPY as a reference), we can see that this ratio is still well above its rising 50-day moving average. Relative to the equity market, bitcoin therefore still looks quite strong.

More questions than bitcoin's dollar price are raised by the internal dynamics of the crypto market. The altcoin market, which performed strongly in September, has started to weaken clearly against bitcoin in early October. The ratio of total altcoin market cap to bitcoin's market cap (TOTAL3ESBTC) has quickly fallen below all of its key moving averages.

This suggests that crypto investors have turned clearly more cautious in recent weeks.

On its own, this does not of course mean that the crypto market's rally has necessarily come to an end. It is worth being aware, however, that almost without exception, more significant moves lower have begun with a clear weakening of altcoins. In our view, the developments of the past two weeks therefore give good reason to watch the crypto market especially closely in the near term for possible larger moves lower.

Theme idea: defensive stocks

This week, we are highlighting the equity market's defensive sectors as our theme idea.

As noted earlier, the technology sector has weakened in recent weeks, while many other sectors have strengthened. Among those strengthening, the so-called defensive sectors and the energy sector have looked strongest.

The energy sector has once again received a lift from rising oil prices, and many energy sector ETFs have risen to new record highs.

The healthcare sector also appears to be turning higher after a few weeks of consolidation.

The consumer staples sector also looks quite interesting.

It should be made clear that a situation in which energy, healthcare and consumer staples look like the strongest sectors of the equity market does not exactly signal growing risk appetite among investors.

As noted earlier, we are not yet drawing far-reaching conclusions or predicting a major correction in the equity market. However, if an investor wants to protect against possible moves lower in the equity market, these sectors could offer quite good options for doing so.

The financial markets are in a new and interesting situation. Two weeks ago, the biggest concern appeared to be the rapid deterioration of market breadth and concentration in the technology sector. Over the past two weeks, market breadth has started to improve, but the relative weakness of the technology sector has become the next question mark.

The key question for the coming week, then, is whether we will see investors' risk appetite return and the technology sector start leading the market again, or whether a clearer shift towards a more cautious stance lies ahead.

Wherever the market goes, we will keep following the situation and keep you up to date, so stay tuned!