Tech’s on Summer Break — Hotter Stocks Steal the Spotlight

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Send in the National Guard! Tech stocks are red!

The tech sector plummeted nearly 2.5% on Monday following weeks of melt-up action. And the main culprits were some of the same stocks responsible for dragging the averages higher this year, specifically the semiconductors.

The VanEck Vectors Semiconductor ETF (SMH) continues to fill those gaps, dropping more than 3.4% yesterday — its third straight decline. It’s now fallen nearly 8% from last week’s highs.

But a funny thing happened as tech stocks took a beating…

The rest of the market started to perk up. All those forgotten stocks the semis steamrolled in June are suddenly attracting fresh buyers.

You’ve probably heard rumblings about the market’s little breadth problem recently. Despite the impressive win streaks posted by the S&P and Nasdaq, recent action hasn’t looked very healthy. It’s the same old story: A small number of massive stocks have consistently driven the market’s gains.

Under the surface, most stocks were struggling. The Bulls had an opportunity to take control following the May CPI release and positive Fed minutes earlier this month. Instead, we were treated to more than a handful of false moves as stocks gapped higher, only to fail and slip lower. They fumbled the ball, and the semis and mega-caps picked it up and ran with it.

Like most indicators, breadth doesn’t matter… until it does. And if the market can keep the party going, it will be because the laggards catch higher as overbought tech resets.

To be clear, trading a market rotation doesn’t mean you should sell all your stocks and hide under the bed. Instead, you should attempt to find and exploit the sectors that are perking up and beginning to outperform.

We’ll get to the details in just a minute…

But before we get down to business, we need to pause for a moment to reflect on the insane market strength we’ve witnessed so far this year — and where it might be headed next.

Crowded at the Top

Barring a huge move in either direction this week, the Nasdaq Composite will finish the first half of the year sitting pretty with a gain of almost 20%. The S&P isn’t too far behind, clocking a year-to-date gain of more than 15%. Of course, historic performances from some of the biggest stocks on the market have played a major role in the market’s first-half surge…

Semiconductors and the Magnificent Seven mega-caps have foiled the bears at every turn and powered this most recent push to all-time highs, even as breadth has deteriorated and other stocks and sectors have failed to keep up the pace.

Simply put, it’s getting a little crowded at the top. Here’s a telling passage from a recent MarketWatch piece:

The ‘Long Magnificent Seven’ trade has kept its spot as the most crowded trade for the 15th month in a row, according to Bank of America’s Global Fund Manager Survey, which shows 69% of fund managers now view it as the most crowded trade, versus just 51% in May.

The bet on the seven high-performing tech stocks is now viewed as more crowded than any comparable trade since the 2020 dotcom rally when fund managers repeatedly cited ‘Long U.S. Tech’ as the most crowded trade, including in July (74%), September (72%) and October (80%) that year.

The result of this mega-cap dominance has been an incredibly smooth ride higher — a rally devoid of the typical gut checks and resets that keep investors honest and punish anyone who gets the itch to take profits too early.

Here’s a fun tidbit making the rounds: The stock market has now gone almost 380 days without a one-day selloff of at least 2%, which CNBC notes is its longest stretch since the Great Financial Crisis. The kicker is that the S&P hasn’t posted a 2.15% gain over this same stretch, either. Volatility is virtually nonexistent as stocks quietly push higher.

The most recent comparable conditions would be the low-volatility melt-up months of 2017. Seven years ago, the S&P notched “just eight daily moves of more than 1%, while the VIX fell to historic lows below 9.” according to CNBC.

But Summer is here — a time when more difficult market conditions could prevail. That doesn’t necessarily mean we’re going to see a big move lower. But I expect choppy action at the very least, even if we do see a bigger market rotation begin.

If markets do remain choppier for longer, I don’t want to be fighting gravity. Yes, we’ll be looking to add downside plays if breakouts fail and stocks begin to trend lower. But that doesn’t mean we won’t find solid long opportunities.

Rotating the Bull

While most investors and the financial media can’t take their eyes off NVDA and the semis right now, we’re starting to see some viable rotation trades brewing.

For starters, the Dow is in the midst of a five-day win streak as some of its non-tech components fight higher.

Financials and industrials — two groups that have not posted new highs this month — continue to firm up. Both finished Monday trading in the green.

Energy is another strong contender for a summer rotation play. Crude has retaken $80 and the big oil and gas companies posted market-leading moves to kick off the trading week. You might recall that the energy sector posted a huge breakout move in April. XLE rallied double-digits, only to run into trouble in early April — and it’s faded ever since.

What about small caps? The Russell 2000 looked like a world-beater during the Q4 melt-up rally as it posted a 20% move off its lows. But it’s been a choppy mess for the past several months after it failed to extend higher in the first quarter. Can it finally break free of its choppy range and extend higher? Remember, it’s grossly underperformed the major averages for nearly two years. Yesterday’s gains were a start… but it needs to follow through.

Bottom line: Don’t sweat the semis. They’ll reset and potentially offer strong buying opportunities once they blow off some steam.

For now, concentrate on the names that are showing signs of life as tech fades. And of these plays could quickly become market leaders this summer.

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