Is the tech sell-off over? This strategist says no.

While technology has driven the market’s impressive gains last year and this year, the number of stocks still surging has dwindled. If 2023 is the year of the “Magnificent Seven,” Nvidia is now the “Magnificent One.” The artificial intelligence craze that ignited the tech industry last year has been mostly concentrated in semiconductor stocks this year, hurting sectors like software.

Given all that, it makes sense to view Wednesday’s selloff, and the subsequent selloff in tech stocks following news last week that inflation fell more than expected in June, as normal market movement. The theory is that with inflation under control, the Federal Reserve will cut interest rates, benefiting a range of stocks. Many strategists, including those at Capital Economics, see it as inevitable and natural for investors to pull money out of tech and into other areas.

The problem, of course, is that even if that’s the case, semiconductor stocks have become so large that even a healthy move away from them would lead to losses across the major indexes. Interactive Brokers made this point last week when positive news about inflation was overwhelmed by a selloff in semiconductor stocks.

It would be even more worrying if this wasn’t just a move toward cheaper stocks but a sign that the market is in a bubble.The huge gains in tech stocks have been compared to the ultimately disastrous surge in dot-com stocks at the turn of the century, but most who see the similarities don’t think the bubble will burst anytime soon.

Albert Edwards, Societe Generale
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Chief global strategist John McClellan thinks that view may be too optimistic: While there are many reasons why a bubble can pop, “a simple reversal in price momentum in an asset class that has been surging for several years (soaking up a lot of liquidity) is often enough for investors to rush to sell and prices to crash,” he wrote in a research note.

Mizuho
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Jordan Klein wrote last week that when semiconductor stocks sell off, the situation can easily snowball. “Momentum strategies tend to sell first and question later when they see a potential pullback or rotation,” he said.

Edwards is also unfazed by the fact that profits are rising along with stock prices, providing fundamental support for rising stock prices. “But those of us who lived through the 1990s will recall that the Nasdaq bubble of that time was fueled in part by real investment that turned out to be overcapacity,” he wrote. “This Ponzi investment boosted sector profits, but not enough to justify valuations. Some skeptics are already warning that the current AI boom has similar characteristics.”

Additionally, he noted that unlike previous periods, earnings per share growth forecasts are well ahead of actual EPS increases. “And how similar is this earnings per share growth frenzy to the telecommunications industry’s ‘free’ money-fueled overinvestment in cable in the late 1990s?” he wrote. “We may find out soon!”

Of course, Edwards is known as a perennial bear, and as the “alternative view” at Societe Generale, he acknowledges that he is more pessimistic than the firm’s other equity strategists.

Still, he wrote, “this benign rotation could easily turn into a self-fulfilling market crash” that could lead to a recession if the situation plays out as it did in early 2001. “This is a reminder of just how fragile the economy is right now,” he wrote.

The bulls appeared to have regained the upper hand early Thursday as the Nasdaq rose, but the index turned lower later in the morning. If such swings become more frequent, more investors may start to question the momentum of tech stocks.

Email Teresa Rivas at teresa.rivas@barrons.com.