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 The Behavioral Psychology Behind This Tech "Rout" - brain image

Tech rout? That's the latest narrative being passed around by the mainstream media:

  • CNBC: The big tech rout may just be getting started
  • Reuters: Tech rout sparks search for value
  • Bloomberg: Europe Stocks Gain as Tech Rout Fades; Pound Rises

The Nasdaq is down -1.9% from last week's all-time high. The Russell 2000 and S&P 500 are down -0.5% and -0.3% respectively from their recent all-time highs. 

Some "rout" ...

If you're bullish on Technology (XLK) stocks and smartly booked some gains near the all-time highs the question now is why? Why book gains? What were the signs that suggested a sell-off was becoming increasingly probable? And what's next for Tech shares?

First off, any time an asset hits a new all-time high represents time for reflection, especially after a rally of nearly 20% rally year-to-date like the Nasdaq's.

But it's more than that. "If you’re measuring/mapping price, volume, and volatility data, across durations and market factors, daily… you’ll remember that as the Nasdaq was registering overbought highs," writes Hedgeye CEO Keith McCullough in today's Early Look.

McCullough is talking about his quantitative risk range model, which measures the daily probable trading range of an asset using its underlying price, volume and volatility. Basically, the price of a stock, bond, currency or commodity can fluctuate between the top-end (a sell signal) or bottom-end (a buy signal) of it's daily trading range based on underlying market fundamentals.

Put simply, it spits out prices to better help investors buy low and sell high. And after Nasdaq's all-time highs last week, McCullough's daily trading ranges suggested the Nasdaq was overbought.

There were other signs of this too.

From a behavioral, markets perspective, formerly bearish investors had capitulated and bought stocks into the all-time highs. The Chart of the Day below shows investor positioning in futures and options markets.

The spikes in the graph show investors' expectations of future volatility in the Nasdaq above the past 30-days of volatility. Just before the Nasdaq hit yet another all-time high last week, "implied" future volatility expectations over historical volatility had fallen from year-to-date highs, hit just two months ago, to then year-to-date lows. Investors were dumping bearish bets as the Nasdaq went up and up and up. 

That was a worrisome sign, a dangerous mix of capitulation and complacency.

Fast forward to today, post-Tech "rout," the Nasdaq now has an implied volatility PREMIUM (i.e. the ratio of expected future volatility to historical, realized volatility) of +15%. Basically, investors are bearish again, after the sell-off.

So if you're reading this chart below correctly it says that investors have been too bearish into all-time highs, then capitulate, then freak-out in the ensuing sell-off, dump shares and get too bearish again. 

The moral of the story is to have a process that checks your emotions. Instead of freaking out, ask yourself some fundamental questions that shape macro markets. Is U.S. economic growth accelerating or slowing? Is inflation growth accelerating or slowing? (Click here for more on what we thinking about both and here for "Why You Want to Be Long Large Caps, Growth Stocks & Tech.") 

The real money is made by understanding these precipitating factors and not getting whipped around by the market's wild, gyrations. 

The Behavioral Psychology Behind This Tech "Rout" - 06.13.17 EL Chart