We've Seen This Before In Tech: What Happens Next?

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 |  Includes: FTEC, IGM, IYW, QQQ, ROM, RYT, TDIV, TECL, TECS, VGT, XLK
by: Dave Allen

Summary

Tech stocks are down 7% over the past two weeks. What happens next? – Investigated through historical precedence.

A look at the YTD price of the Morningstar Technology Index, with history dating back about 25 years, found 21 similar instances of the current 3 ½ month price.

The Tech Index is up in 15 of the 21 historical instances (71.4% of the time), and the average return of all 21 in the next one month is 2.7%.

"Isn't life a series of images that change as they repeat themselves?" - Andy Warhol

Tech stocks have been beaten up quite a bit over the past couple of weeks. The Nasdaq 100 Tech Index (NDXT) is down 7% since April 1st. The Fed continues to taper with the end of QE in sight. Concerns over valuations are growing. With Q1 earnings upon us, and forecasts of lower corporate profits looming, there's legitimate cause for trepidation with tech stocks. Will the bloodletting continue?

At times like these, there's no better gauge for what is likely to unfold next than historical precedence. Specifically, capturing what we've seen in environments like this in tech stocks historically. What happened next gives us a range for the likely outcomes today. That's not to say that I'm suggesting the last few months in tech stocks is exactly similar to periods historically. The circumstances surrounding each environment historically varies (sometimes widely), but investor reactions to these periods is often consistent. Understanding how they are likely to react once again is invaluable.

Pulling together an objective, historical precedence for each investment decision is not something most investors have been able to incorporate effectively in the past because of the time commitment. When have we seen similar environments in the trading of tech historically and what typically happens next? I decided to investigate.

I looked at the YTD price of the Morningstar Technology Index, with history dating back about 25 years, and found 21 similar instances of the current 3 ½ month price trend. The Tech Index is up in 15 of the 21 historical instances (71.4% of the time), and the average return of all 21 in the next one month is 2.7%. This is a positive projection, and my market call is for a positive move in the next month, but there's more to the story and the range of outcomes are important.

YTD price trend in the Morningstar Technology Index

Click to enlarge

(SOURCE: EidoSearch data 4/13/14)

The 21 most similar historical instances of the current price trend, and the one month forward return of each.

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(SOURCE: EidoSearch data 4/13/14)

Projection chart showing the wide range (orange bounds) of potential outcomes in just the next one month forward period based on historical precedence.

Click to enlarge

(SOURCE: EidoSearch data 4/13/14)

Just focusing on the six instances historically that are down in the next month, they are all down at least 5%. In the summer of 1996 it was down 13% (best depicted by the last chart below). This is a wide range for a one month period, and although the projection is positive based on the average outcome, the risk profile is not as appealing. The numbers suggest we tread lightly, but of course putting these signals in the hands of an experienced investor makes this data much more meaningful and in most instances actionable.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.