UK Markets closed

After riding the momentum trade, tech investors take some profits

Bob Pisani

As goes tech, so goes the market.

We saw it on Tuesday. In the middle of the morning, semiconductor stocks — many of which have advanced 20 percent or more this quarter — began weakening, and the rest of the market followed suit.

The VanEck Vectors Semiconductor ETF closed down 1.4 percent, its poorest showing since Feb. 9, during the height of the craziness around inflation and volatility worries.

What does this mean? With two weeks left in the quarter, traders are nervously eyeing hefty gains in technology stocks as it becomes increasingly clear that the market leadership is very stretched.

You can understand the concern: The S&P is up 3 percent, but technology is up more than three times as much, 10 percent this quarter.

Technology is now roughly 26 percent of the market capitalization of the S&P 500. That has attracted enormous amounts of short-term momentum money that will be quick to pile in but also quick to pile out, particularly around the end of a quarter.

It's not just semiconductors, which as a group are up 14 percent. Anything associated with social media, cloud computing or cyber security has also risen in the mid-teens in the last several weeks, based on the returns of ETFs tracking the sectors:

Q1 Market Leaders

Technology: up 11 percent

Social Media (SOCL ): up 15 percent

Semiconductors: up 14 percent

Cyber Security (HACK ): up 14 percent

Cloud Computing (SKYY ): up 12 percent

Source: CNBC

With earnings improving, there's nothing necessarily wrong with strong gains, but in recent weeks the gains have gone parabolic for a number of these stocks. A good way to look at this is through the Relative Strength Indicator, a short-hand way of looking at how fast stocks have been going up or down in the last two weeks.

Simply put, the RSI measures momentum on a scale of 1 to 100. Under 40 is oversold (buying opportunity), over 70 is overbought (susceptible to selling). Over 80 is stupidly overbought (warning). When you get close to 90, well, it's almost impossible to sustain that kind of upward momentum. Stocks either drop or, in a best case scenario, stop going up.

A lot of well-known stocks are in this stupidly overbought category:

Semiconductors: overbought

(RSI >70 = overbought)

Micron 90

Microchip Tech 88

Lam Research 82

Xilinx 82

And a lot of well-known software names are in the same camp:

Software: overbought

(RSI >70 = overbought) 86

Splunk 86

RedHat 83

ServiceNow 81

Stocks that are this overbought are susceptible to sudden bouts of profit-taking, which is exactly what happened Tuesday.

So is this the end of the tech rally? It seems unlikely. No matter the political craziness in Washington, tech has been able to outperform because of the strong fundamentals.

The key story is that the fundamental background has not changed: we have synchronized global growth and stronger earnings. The two big negatives, inflation and trade wars, both diminished last week.

In the past, when tech has led to the downside, it hasn't lasted very long.

As long as that backdrop remains strong, this still seems like healthy profit-taking.