Could tech make another run?

Jay Kaeppel

2022-04-06

There seems to be a sense of foreboding regarding technology stocks. Many investors believe that a decline - ala the 2000-2002 dot com bust is inevitable. And there is a chance they are right. But several key factors are lining up the bullish side of the ledger that question this line of conventional wisdom. In this piece, we highlight the details.

Key Points

The conventional wisdom suggests that technology has had its "day on the sun" - and that a significant decline, ala, 2000-2002, is inevitable
Nevertheless, a variety of reliable factors are presently lining up on the bullish side of the ledger
These factors include insider buying, sector correlation, breadth, and technology's typical response to specific bullish market indicators

The state of the technology sector

The chart below (courtesy of Stockcharts.com) displays price action for XLK (Technology Select Sector SPDR Fund) for the past three years.

There are three things to note:

Tech has enjoyed a phenomenal run
Tech dropped below its 200-day moving average, prompting much speculation regarding a potentially imminent bear market
Tech has since bounced back somewhat

As long as the price holds above the 200-day moving average, investors may be wise to give the bullish case the benefit of the doubt, particularly in the items detailed below. If the price slips back below this moving average, a higher degree of caution is warranted.

Factor #1: Insider buying

Ticker XLK (name) is an ETF that tracks the S&P 500 Technology Sector Index. The chart below displays the level of open-market share buying done by corporate insiders among the constituent companies in the index.

As you can see in the chart above, corporate tech insiders have been on a major buying spree for most of the past 17 months. The chart below displays a summary of XLK price performance following all weekly Corporate Insiders Buys - XLK readings above 17.

There is no guarantee that future performance will be as robust as the above historical results. But the main point here is recognizing that corporate tech insiders are betting heavily on their stocks with their own money. They typically are not wrong when they act en masse.

Factor #2: XLK Component Correlation

This indicator shows the correlation among members of the sector. During times of panic, investors tend to buy or sell "everything" together, no matter their individual merits, so correlation rises. The higher it goes, the more we're seeing group-think, which tends to happen at times of extreme pessimism, and is thus usually a positive for stocks going forward. The chart below highlights those times when this indicator crossed above 0.70.

The table below displays a summary of XLK performance following the dates highlighted in the chart above.

As you can see in the table above, performance during the first month after a cross above 0.70 has been generally unfavorable. However, the returns are pretty consistently favorable and significantly positive after that. The latest signals occurred on 3/29/2022.

Factor #3: XLK McClellan Oscillator

The McClellan Oscillator is a breadth indicator that measures the difference between two advance/decline moving averages. The chart below highlights those times when the XLK McClellan Oscillator crossed above +100 while the price of XLK shares was above its 200-day moving average.

The table below displays a summary of XLK performance following the dates highlighted in the chart above. The results are not necessarily spectacular; however, they have been solidly favorable across all time frames. The most recent favorable signal occurred on 3/28/2022.

Factor #4: Smart Money/Dumb Money Confidence Spread

A bullish signal for the overall market typically occurs when the 20-day moving average of the Smart Money/Dumb Money Confidence Spread crosses above 0.45. The technology sector typically responds quite favorably following such signals as a leading sector.

The chart below displays XLK and when the 20-day moving average of the Smart Money/Dumb Money Confidence Spread crossed above 0.45.

The table below displays a summary of XLK performance following the dates highlighted in the chart above. The results for XLK have been robust, particularly during the first three months after each previous signal. The most recent favorable signal occurred on 3/10/2022.

What the research tells us…

Given the spectacular advance that the technology sector enjoyed following the 2020 Covid-19 low - and really since the 2009 low - many investors cannot believe there is much more upside left for this sector.

And they could be right.

Nevertheless, let's look solely at objective indicators such as the ones highlighted above - particularly the unwavering real-money commitment of corporate insiders (who know better than anyone what to expect regarding future corporate growth). It may be wise to give this key sector the bullish benefit of the doubt as long as the price holds above its 200-day moving average, and/or recent support.