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Business News/ Markets / Stock Markets/  Where danger lurks in the big tech rally
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Where danger lurks in the big tech rally

wsj

Unbridled optimism, the impact of options, and the speed and scale of the gains have left the rest of the stock market in the dust

New York Police Department (NYPD) vehicles pass in front of the Nasdaq MarketSite in the Times Square neighborhood of New York, U.S., on Monday, July 20, 2020. U.S. stocks fluctuated in�light trading�as investors are keeping an eye on Washington, where lawmakers will begin hammering out a rescue package to replace some of the expiring benefits earlier versions contained.�Photographer: Michael Nagle/Bloomberg (Bloomberg)Premium
New York Police Department (NYPD) vehicles pass in front of the Nasdaq MarketSite in the Times Square neighborhood of New York, U.S., on Monday, July 20, 2020. U.S. stocks fluctuated in�light trading�as investors are keeping an eye on Washington, where lawmakers will begin hammering out a rescue package to replace some of the expiring benefits earlier versions contained.�Photographer: Michael Nagle/Bloomberg (Bloomberg)

It’s been a terrible two days to be an Apple shareholder. Yet, after falling 8% on Thursday and swinging wildly to end flat on Friday, the price is all the way back down to where it was, um, two weeks ago.

Investors might reasonably worry that this is the start of a bigger correction. There was far too much enthusiasm for the big disruptive technology stocks, so prices could go down a lot more. Yet, there are still good reasons for liking companies whose growth has been helped rather than hindered by the pandemic.

To assess just how bad things could get, we should start by examining the warnings that have been flashing recently. I’ll do that today, then in subsequent columns come back to the questions of what is likely to trigger a major reverse in these popular stocks, whether it has already begun and what the broader effects on the rest of the market and the economy could be.

The danger signs cover three broad areas: overly optimistic sentiment, the impact of options trading, and the speed and scale of the rise of leviathan technology stocks, which have left much of the rest of the market in the dust.

Any indicator tied to the big tech stocks shows how sentiment is extremely positive, aided by the return of the day trader. This shows up both in the stock and option markets, where Japan’s SoftBank has poured in roughly $4 billion. Most obviously, trading volumes on Nasdaq, where most of the tech stocks are listed, are running at more than double their levels before the pandemic, while trading in NYSE stocks—which had surged when markets plunged—has fallen almost all the way back down to normal.

Day traders piled into options, too, especially the call options that offer a way to multiply one’s money if the market rises—or lose it all if it falls. Options trading has taken off as brokers made it free, and is focused on the big, popular stocks. As a result, they became a lot more volatile, even as the price rose, because the brokers have to hedge their positions. Hedging call options accentuates moves in the price, because when the stock price rises, the dealers need to buy more to cover their risk, and when the price falls they can sell.

The optimism of SoftBank and the day traders is visible in the ratio of calls on individual stocks to the defensive put options that protect against losses. Smoothing the noisy ratio over 10 days, on Wednesday call options outnumbered puts by the most since March 2000, the height of the dot-com bubble. In the midst of Thursday’s sharp price falls, traders rediscovered the value of caution, and puts became popular again, with the unsmoothed ratio returning to its long-run average.

Options are intimately tied to volatility, and volatility has been weird. The VIX index of implied volatility on the S&P 500 usually falls when stocks rise a lot, but in the past two months it has risen even as the S&P had some of its best returns in history. The breakdown of normal market relationships is a good reason to worry.

Even as tech optimism is obvious, sentiment in much of the rest of the market remains morose. Bears still outnumber bulls in the weekly survey of members of the American Association of Individual Investors—a group that doesn’t capture those new to trading since lockdown.

The split is captured by the gap in performance of the growth stocks and cheap stocks, known as value. By Wednesday’s high, the Russell 1000 measure of growth stocks was up by a third this year, while the value index was down almost 8%.

Still, the excess is different from that of the dot-com bubble. Back then, stocks thrived on hope, with little in the way of sales and profits a figment of someone’s spreadsheet. This time, the stocks that are up a lot are frequently highly profitable, and almost all are winners from the pandemic and from low bond yields. The danger isn’t that they prove worthless, as with so many dot-coms. Instead, it is that investors are projecting that every year will be like this year.

Perhaps the biggest pandemic winner is Zoom Video Communications, which scored the rare success of turning its name into a verb. Sales and profits are soaring—but the shares are soaring even more. At 144 times its own upgraded forecast of operating profits (adjusted, but let’s be optimistic!) its shares are priced not only for work-from-home to become the norm, but for Zoom to beat deep-pocketed contenders for the verb, such as Microsoft-owned Skype, Google’s Meet and Facebook’s WhatsApp.

Thursday’s price moves showed what can happen when investors change their minds. Zoom shares plunged 10%, while the biggest gainer in the S&P 500 was stricken cruise line Carnival, with a 5% rise. Other lockdown losers also leapt.

The big tech stocks might have fallen, but they remain enormous. The market hasn’t been so dominated by a handful of giants since the 1970s. The value of just the big five of Amazon, Apple, Alphabet, Facebook and Microsoft rose by $2.87 trillion in the year to Wednesday, just ahead of the $2.85 trillion rise in the S&P 500’s value. The five then lost an astonishing $522 billion of value on Thursday and Friday.

The difficulty with calling what’s been going on a bubble is that it makes sense that the companies performing the best should also have the top-performing shares, and the shares of the companies doing the worst should plummet. When views on the pandemic and the political reaction switch, the winners rightly fall back and the losers jump.

The trouble is that momentum has taken hold too. The gap between the winners and losers is vast; on some measures it’s the biggest ever. Small changes in reality or in sentiment can lead to big rotations when that gap closes just a little, as in this week.

So much for the warnings. Next I’ll address the question of whether the declines of the past couple of days are preparation for tech-stock Armageddon, or merely blowing some froth off an otherwise reasonable investor reaction to a global upheaval.

Write to James Mackintosh at James.Mackintosh@wsj.com

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