02/06/24 09:14 AM EST

Warning: Concentration in Massive Tech Sector

Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here.

A quick historical review, while we reflect on market dynamics, consider the shifts witnessed at the century's turn. Steering clear of the imploding dot-com sector and favoring energy would have reaped a 150% reward in the 2000s, while tech and telecoms could have halved your wealth, even before accounting for inflation. Fast forward, and the tables turned dramatically post-Great Financial Crisis. From 2009 to the close of last year, a tech-overweighted portfolio would have ballooned by over 1600%, dwarfing the S&P 500's 600% gain and leaving energy's 164% increase trailing in the distance. Ed Harrison of Bloomberg has done excellent research on understanding the duration involved with sector rotations. Sector rotation is fundamental, and though 2009 was stellar for tech, entering a year later would still have yielded substantial outperformance.

Large-cap giants carry steep earnings multiples, banking on their potential for growth and operating leverage in winner-take-all markets. Whether such multiples are inflated can only be known in the future.

We have previously drawn parallels with 1999, with Prof Plum noting the change in index construction from market-cap weighted to float-weighted buying capacity for passive strategies that has now run out. While today's valuations are generally lower, the risk from intense sector rotation looms larger, with the Magnificent 7's heavy index weight and valuation disparities. The biggest danger is the very concentration that’s propelled markets to where they are.

In prior periods, comparisons were made between tech giants and entire sectors like energy or utilities. Today, those analogies can be extended to entire economic regions. To roughly compare the NDX to the Russell 2000:

When the economy and the markets both enter a downturn, it's common to see former sector front-runners not just lose their edge but actually decline significantly, trailing behind the overall market for extended stretches.

Learn more about the Market Situation Report written by Tier 1 Alpha.