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Thursday, 10 August 2017

Finance: Scorching-hot tech stocks are getting a makeover that could lead to their downfall

Scorching-hot tech stocks are being used in a new way that could lead to their downfall.

Investors have started to trade tech stocks — historically a vessel for cyclical growth — as a safe, risk-averse alternative to bonds.

Tech stocks are getting a makeover.

Though the stocks were historically a way to chase cyclical growth, investors have started to trade them as a safe, risk-averse alternative to bonds.

At the heart of the shift is the dearth of price swings in tech shares, which has been a byproduct of the sector's recent success. As the group known as FAAMG — Facebook, Apple, Amazon, Microsoft, and Google — has produced world-beating returns, their rising cash balances and a lack of market shocks have sapped the entire tech sector of volatility, Goldman Sachs says.

That low volatility has shifted the industry's entire profile. Tech is now more highly correlated with consumer staple and utility stocks — both defensive groups offering reliable yields — than at any point in the past 15 years, according to Goldman's data. On the flip side, tech is less correlated with "risk-on" areas like financials, industrials, and materials than it has been in, you guessed it, 15 years.

By extension, tech is also now negatively correlated with interest rates, a reversal of the usual relationship. So as the Federal Reserve takes its time with monetary tightening, it plays right into the hands of the surging tech sector.

Sounds good, right? Well, it may not be.

While Goldman concedes that the ongoing situation in tech is working for the time being, it's less optimistic about what could happen if the broader market faces a shock. If price swings come back in force, the party could be over.

"We believe low realized volatility can potentially lead people to underestimate the risks inherent in these businesses," Robert Boroujerdi, the head of global securities research at Goldman Sachs, wrote in a note from June. "Mechanically, we expect that as the realized volatility of a stock drops, more passive 'low vol' strategies buy the stock, pushing up the return and dampening downside volatility. The fear is that if fundamental events cause volatility to rise, these same passive vehicles will sell and exacerbate downside volatility."

In tech's wake lie healthcare stocks, which were previously a popular bond proxy but are now seeing their lowest correlation in 15 years with consumer staples stocks.

It's entirely possible these sectors will revert back to their historical roles. But with the US market fresh off several rounds of unprecedented economic stimulus, and with the Fed about to embark upon an unprecedented balance-sheet unwind, it's safe to say the investment playbook is being rewritten on the fly.



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