High Flying Tech Leaders Down - Market to Follow?

by: David White

A huge list of some of the fastest growing stocks fell dramatically yesterday. The list includes: CRM, NFLX, RVBD, EZCH, BIDU, VMW, RDWR, FFIV, APKT, and EQIX. Most of these were down 5% to 10+% in one day. This happened on a day when the SPY was little changed for the day, and the DIA was actually up from its open. This is actually a very bearish signal. These stocks have been leading the market higher. They were far over valued (and still are). This was likely due to investor speculation that they could be buyout targets. For most the problem with that rationale was that they were already too highly valued to be viable buyout targets. Wed. the market seemed to finally acknowledge that. However, that is not likely to be the end of it. The HFT/momentum/market emotion traders have been pushing them up. They are generally only interested in quickly moving stocks. Some may now try to push these same stocks down further (so they can again be pushed up quickly. Others such as most HFT may simply remove their push up. This will drain liquidity, and it will eliminate perhaps 70+% of the up volume. What do you think will happen to these stocks under that scenario?

The overall market is over bought, after going up for all of Sept. and more slowly in Oct. The above techs (and this is not a complete list) will not be able to lead for the near term. They seem more likely to be in retreat mode. Most of the multiples are truly outrageous. Financial stocks seem unlikely to be able to lead. The real estate crisis is still prominently in the news. Foreclosure problems facing the banks have been headlined every day. The Irish banks’ and government’s problems have never been far from the news. California’s teacher pensions obligation deficit of $326B (the GDP of Ireland) was highlighted Wed. The lower amount of trading recently has been highlighted for US investment banks. FinReg consequences have been cited as reasons for near term bank layoffs and reorganizations to come. The tax consequences of the Health Care bill and the FinReg bill are only just starting to get the US markets’ attention. The full amount of the changes and damage to current business operations in these two sectors is only beginning to be felt.

Much of FinReg has not even been written yet. There will be bad mistakes in that process. Health Care companies are having to implement a new system for Obama Care. Plus they still have to update their old systems as best they can to get some changes immediately. All this is very costly. The world growth estimates are being lowered (Wed. it was the IMF lowering its 2011 world growth estimate by 0.1%). The EU countries are implementing austerity measures to bring their budget deficits eventually down to a maximum of 3% of GDP. This can only lead to further slowing.

The fact that the Euro has been rising (ditto the Yen) has to hurt these troubled countries even more. There will be no miracle recovery in the near future. GS’ Hatius raised his estimate of the probability of a new recession to 25% to 30% from a beginning of 2010 15% to 20%. Does this sound like everything is rosy? Samsung Electronics (OTC:SSNLF) just gave lowered forward guidance. Plus none of the major tech names (CSCO, HPQ, MSFT, INTC, etc.) seem to have moved up significantly during this rally. Some have been downgraded, even though their multiples are fairly low. Is this the sign of a market about to take off?

If the leaders (the high flying tech stocks) just died yesterday, what will take their place? Energy? That has already run up recently. Plus its improvement is normally tied to improved economic conditions. Those don’t seem to exist right now. In fact the job market seems to be stagnating, or even reversing without ever having reached a real positive job creation state. Some are saying the Fed will rescue everything with more quantitative easing, but others experts are saying this likely won’t work, including the IMF’s chief economist, Blanchard. Many market timers are calling for a 10% to 15% pullback near term. After seeing the behavior of the tech leaders Wednesday, let me add my voice to that group.

Below is a chart of the SPY. It gives a good idea of likely behavior. The market seems to be stopping at the resistance from the January high.

The SPY has broken slightly above its resistance line, but it has bumped directly into its top Bollinger Band (an over bought indication). The Williams %R indicates a highly over bought condition. Plus the SPY is significantly above all three SMAs (20-day, 50-day, and 200-day) on the above chart. Probability says the SPY is more likely to fall in the near term (a failed break above its resistance line from last Jan.). The fundamental economics of the world argue even more strongly for a near term fall. When the market leaders give up, the run may be over.

Good Luck Trading.

Disclosure: I am currently short NFLX and the SPY.