How crowded is the tech stock?

Dot-com redux?

Many investors are wary of technology stocks despite their strong performance over the past few years. The dot-com bubble burst in the early 2000s cast a long shadow.

Such fears can be overwhelming. The gains in technology-heavy NASDAQ and S&P 500 in recent years have been more moderate than the rapid jump seen at the turn of the millennium. This gives some reassurance that the situations are not quite similar.

NASDAQ and S&P 500 performance

Source: FactorResearch

But if history does not repeat itself, it can still be rhyme. So how crowded are the technology stocks today, especially the powerful Fang V of Facebook, Amazon, Apple, Netflix and Google? After all, in its other lessons, dot-com bubbles illustrate the risks of crowded stocks. A sudden change in market sentiment can cause many investors to try to unload the same equity at the same time. If there are some natural buyers left in the market, the losses may increase further.

Crowd metrics

To measure congestion across the entire technology sector, we borrow a model that measures the congestion of equity factors. Given the strong performance of technology stocks in recent years, many Long Momentum Factors are now included in the portfolio, shortening the winning buyers and losing stocks. At certain times, the current, momentum factor among them exhibits significant exposure to the technology sector and provides a useful way to compare. The goal of the crowding model is to identify the technology sector or momentum factor when it is crowded, which displays the drawdown after an unattractive sector or factor.

Different methods measure crowds. Our vision focuses on metrics obtained from the market that are available daily or even intra-day. We combine five systems that indirectly reflect changes in a sector or factor and often indicate when a significant flow or outflow is occurring. They are:

  • Residual instability
  • The remaining interrelationships
  • Residual scattering
  • Differences in market valuation
  • Performance

All of these metrics are positively related to the crowd. That is, the greater the residual volatility or the greater the difference in market valuation, the greater the likelihood of congestion.

We standardize the five metrics and combine them into one score. According to the model below, the technology sector was crowded in 2000 and 2018. The reason for the speed was also the crowd in 2000, when it exhibited a significant exposure to the technology sector. It was also crowded during the financial crisis of 2008 and 2016.

Multimetric crowding score

Multimetric crowding score

Source: FactorResearch

We can investigate the effectiveness of this method by analyzing the dropdown of the momentum factor after measuring the crowding score. The analysis below shows that the cause of a congestion is associated with subsequent higher drawdowns.

Momentum factor crowding: 15% or more likely to decrease

Momentum factor crowding

Source: FactorResearch

The same approach applies to the technology sector: a crowded sector exhibits more frequent subsequent drawdowns than a non-crowded one. These drawdowns are measured on a market relative basis.

Tech Sector Crowding: Probability of 15% or less

Tech Sector Crowding: Probability of 15% or less

Source: FactorResearch

Current Crowding Snapshot

The Score Dashboard below provides a recent snapshot of all the short metrics and shows that both the technology sector and the momentum factor were crowded, with positive scores on all metrics except for the correlation of technology stocks. The sector and factor in particular have seen a surge in valuations, which may not be too surprising, when technology stocks were more volatile than usual. Momentum factor stocks also showed more dispersion than normal.

Crowding Model: Score Dashboard

Crowding Model: Score Dashboard

Source: FactorResearch

Crowd is not a factor or a negative for the performance of the sector. After all, every investment requires some interest to build performance. A crowded sector or factor shows a lack of interest from investors and is therefore not particularly attractive. The best conditions are between crowds and crowds, not too hot and not too cold.

More thoughts

Recent sales of technology, especially among FAANG stocks, have led to new comparisons in today’s technology sector compared to 2000. But the sector has matured and has many highly profitable, stable businesses, so it is much less risky than it was two decades ago.

Current relative assessment is high but measuring sector risk with assessment is not a perfect science. Valuations can be elevated over a long period of time, often far beyond the horizons of most investors.

Investors are better off listening to multiple signals to measure portfolio risk.

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All post author opinions. As such, they should not be construed as investment advice, or the opinions expressed do not reflect the views of the CFA Institute or the author’s employer.

Photo Credit: © Getty Images / Dina Marian

Nicholas Rabenar

Nicholas Ravener is managing director of Factor Research, which provides quantitative solutions for factor investing. He previously founded Jackdow Capital, a quantitative investment manager that focuses on equity market neutral strategies. Previously, Rabener has worked at GIC (Singapore Government Investment Corporation) which focuses on real estate across asset classes. He began his career with Citigroup in Investment Banking in London and New York. Rabina holds an MS in Management from the HHL Leipzig Graduate School of Management, is a CAIA charter holder, and enjoys endurance sports (100km ultramarathon, Mont Blanc, Mount Kilimanjaro).

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