Okay, I think we can safely file this week’s title under the category of “just one more reason why white guys don’t rap.” Not well, anyway. In any event, as I have mentioned a time or two in the past, it is important and useful to step back every now and then and try to look around to gain some perspective. One of the things that boggles my mind – and which many of us take almost entirely for granted – is the proliferation of technology that has occurred during the course of our lifetimes and the vast impact that these changes have had on all of our lives. I mean for starters just consider that less than two decades ago about the only way you could be reading this article was if it was printed on a piece of paper and mailed to you. Also I am reminded of my grandparents, both born in the late 1800s and who both passed away in the 1970s. During the course of their lifetimes things advanced from "the very finest in horse and buggy technology” to a man on the moon. Talk about a quantum leap. And today just consider the amount of technological power we can hold in the palm of our hand. The bottom line is that technology seems to be advancing at an exponential rate. Now I do not mention all of this simply to say “golly, gee whiz” and to sound like some old fogey who is just trying to keep up (although, sadly, that is probably the net effect). No, the reason for bringing all of this up is to point out the simple fact that if technology is such a driving force in our lives, it would seem to make sense that it would also be a highly influential sector in the stock market. Is that in fact the case? Let’s take a look.A Simple Way to Gauge the Pace of Tech We will use a very simple approach to measure the performance of tech stocks versus the performance of the broader market. As a proxy for tech stocks we will use Fidelity Select Technology fund (FSPTX) and for the broader market we will simply use the Dow Jones Industrials Average (DJIA). The calculations we will use are as follows: A = 63-day percentage rate-of-change for FSPTX B = 63-day percentage rate of change for DJIA C = (A – B) As you can see in Figure 1, technology tends to “swoop and soar” well beyond the movements of the Dow. This is actually not too surprising. The technology sector is more volatile simply due to the nature of the business. One day a tech company can be riding high as they stand at the cutting edge of technology with earnings and sales soaring as demand for their hot new product swells. And then a few short years later their “cutting edge” technology is obsolete (can you say “word processor,” or perhaps someone would like to buy some of those 3.5 inch hard floppies I have in my basement). When the next breakthrough comes one company’s sales will soar to new heights – potentially driving the stock much higher – and another’s will typically vanish, with the concomitant effect on the stock.
Figure 1: 63-day percent rate-of-change for FSPTX (blue line) versus Dow Industrials (red line) since December 31, 1989 In Figure 2 we see the change in FSPTX minus the change in the DJIA. In other words, Figure 2 shows the difference between the blue line and the red line in Figure 1. In a nutshell, technology stocks regularly gain ground and then lose ground to the broader market.
Figure 2: 63-day percent rate-of-change for FSPTX minus 63-day rate-of-change for Dow Industrials since December 31, 1989 Figures 1 and 2 clearly contain some interesting and quite volatile squiggly lines, but of course the real question is, “is any of this useful?” Let’s take a closer look.Using Tech vs. Industrials as a Market Gauge Figure 3 displays the growth of $1,000 invested in FSPTX when the 63-day rate-of-change for FSPTX is greater than the 63-day rate-of-change for the Dow Industrials.
Figure 3: Growth of $1,000 invested in FSPTX only when 63-day ROC for FSPTX is leading 63-day ROC for the Dow since December 1989NOTE: For performance results I assume a one-day lag. In other words, if the value “C” goes positive one day at the close then I assume that FSPTX is bought at the close the following day. There is also a one-day lag when selling. As you can see in Figure 3 the net effect of this simple approach has been a fairly meaningful growth of equity over the past 20 years. There were a couple of “explosions” to the upside (late '90s and 2009) and one truly hideous drawdown (from the 2000 peak to the 2002 bottom). Now for argument's sake, what happens if we use the opposite approach – i.e., buying tech stocks when tech is underperforming the Dow? Figure 4 displays the growth of $1,000 invested in FSPTX when the 63-day rate-of-change for FSPTX is less than the 63-day rate-of-change for the Dow Industrials.
Figure 4: Growth of $1,000 invested in FSPTX only when 63-day ROC for FSPTX is trailing 63-day ROC for the Dow since 1989 The long-term effect of this approach has been a loss of over 30%. Of course, during the great tech bull market of the 1990s sitting out when tech was ‘underperforming” would have meant missing out on some major potential gains. Since the tech bubble burst in 2000, however, the bottom line is that when tech stocks underperform they “really” underperform. Lastly, to fully illustrate the difference in performance by FSPTX when it is leading or lagging the Dow, Figure 5 plots the graphs from Figures 3 and 4 together. As you can see, the difference is quite compelling.
Figure 5: Growth of $1,000 invested in FSPTX when FSPTX is leading the Dow (blue line) versus growth of $1,000 invested in FSPTX when FSPTX is trailing the Dow (red line) since 1989 From what we see here it would appear that a “go with strength” approach definitely appears to have some merit. To put it another way, when the tech stocks are leading the large industrials it is better to be in tech stocks. Conversely, when tech stocks are lagging the big dogs, it is better to simply be in cash.Results – 1989 to Present
$1,000 invested in FSPTX when its 63-day rate-of-change exceeds the 63-day rate-of-change for the Dow has grown to over $15,620 (or +1,562%).$1,000 invested in FSPTX when its 63-day rate-of-change trails the 63-day rate-of-change for the Dow has shrunk to $690 (or -31%).$1,000 invested in the Dow Jones Industrials Average on a buy-and-hold basis has grown to $3,636 (or +263.6%).Where Are We Now? Figure 6 displays:
Blue line = the action of FSPTX since 12/31/2007Red line = the difference between the 63-day rate-of-change for FSPTX minus the 63-day rate-of-change for the DowFigure 6: Tech stock performance (blue line) versus the 63-day percent rate-of-change for FSPTX minus 63-day rate-of-change for Dow Industrials since December 31, 2007 As you can see the red line was negative for most of the 2008 meltdown and turned sharply positive in 2009, proving a harbinger of a major tech rally. Now the red line is flitting about very close to the zero line (in fact it has ticked into negative territory a couple of days in 2010).Summary The results I’ve presented here are something of a Catch-22. While the technology sector (and by the way, the market as a whole) clearly performs better when technology is leading the way, there is a tremendous amount of volatility involved. While the results displayed in Figures 3 and 5 show good overall returns there are also some nasty drawdowns along the way in the technology sector. Also the “bearish periods” displayed in Figure 4 first witnessed an advance of +260% between the end of 1989 and September of 2000. Still, since that time money invested only during the bearish periods has declined in value by -80%. So perhaps the best use of this particular model is as a “filter” to help keep us on the right side of the overall market, rather than as a mechanical trading model. One other disturbing note worth a mention is the recent sharp run up seen in Figures 3 and 5 in technology stocks, which is eerily reminiscent of the sharp run up during the late '90s into early 2000 “dot-com bubble." Wow, maybe I should have titled this piece “Beware of the Tech Bubble.” Of course no one would have read that article because their first reaction would have been “Tech bubble? What tech bubble?” Sometimes things hide in plain sight. I am not necessarily forecasting another tech bubble burst. I am simply suggesting that you keep a close eye on the performance of tech stocks relative to the performance of the overall market for a potential clue as to where things are headed next. The bottom line, though, is this: if tech heads south, there is a good chance that a whole lot of other stocks will go with it. Hey, have a nice day.
Jay Kaeppel Staff Writer and Author of Seasonal Stock Market Trends Optionetics.com ~ Your Options Education Site Questions for Jay? Please visit "Ask the Traders" through the discussion board on the Optionetics.com home page.
NOTE: Jay’s latest book, Seasonal Stock Market Trends: The Definitive Guide to Calendar-Based Stock Market Investing, was ranked among the Top 10 Investment Books for 2009 by the venerable The Stock Trader’s Almanac 2010. For more info, please click here.
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Optionetics, Inc. and optionsXpress, Inc. are affiliated companies under common ownership of optionsXpress Holdings, Inc. Optionetics and its affiliates, officers, employees, independent contractors, and former owners may receive compensation in connection with marketing efforts, may not be registered as a Broker-Dealer, Investment Adviser, with any state, or otherwise, and their materials, products and services may not be reviewed and/or approved. Further information is available here (http://www.optionetics.com/about/legal.asp). Optionetics.com is an educational portal of optionsXpress Holdings, Inc., providing content for educational and informational purposes only. optionsXpress Holdings, Inc. is not a broker/dealer. Investors need a broker to trade options, and must meet certain requirements. All securities, futures, and investments are offered to self-directed investors by optionsXpress, Inc. Member FINRA, SIPC, CBOE, ISE, BOX, ArcaEx, PHLX and NFA. All prices in USD unless noted otherwise. Copyright © 2010 optionsXpress Holdings, Inc. if(typeof ClickTale=='function') ClickFigure 1: 63-day percent rate-of-change for FSPTX (blue line) versus Dow Industrials (red line) since December 31, 1989 In Figure 2 we see the change in FSPTX minus the change in the DJIA. In other words, Figure 2 shows the difference between the blue line and the red line in Figure 1. In a nutshell, technology stocks regularly gain ground and then lose ground to the broader market.
Figure 2: 63-day percent rate-of-change for FSPTX minus 63-day rate-of-change for Dow Industrials since December 31, 1989 Figures 1 and 2 clearly contain some interesting and quite volatile squiggly lines, but of course the real question is, “is any of this useful?” Let’s take a closer look.Using Tech vs. Industrials as a Market Gauge Figure 3 displays the growth of $1,000 invested in FSPTX when the 63-day rate-of-change for FSPTX is greater than the 63-day rate-of-change for the Dow Industrials.
Figure 3: Growth of $1,000 invested in FSPTX only when 63-day ROC for FSPTX is leading 63-day ROC for the Dow since December 1989NOTE: For performance results I assume a one-day lag. In other words, if the value “C” goes positive one day at the close then I assume that FSPTX is bought at the close the following day. There is also a one-day lag when selling. As you can see in Figure 3 the net effect of this simple approach has been a fairly meaningful growth of equity over the past 20 years. There were a couple of “explosions” to the upside (late '90s and 2009) and one truly hideous drawdown (from the 2000 peak to the 2002 bottom). Now for argument's sake, what happens if we use the opposite approach – i.e., buying tech stocks when tech is underperforming the Dow? Figure 4 displays the growth of $1,000 invested in FSPTX when the 63-day rate-of-change for FSPTX is less than the 63-day rate-of-change for the Dow Industrials.
Figure 4: Growth of $1,000 invested in FSPTX only when 63-day ROC for FSPTX is trailing 63-day ROC for the Dow since 1989 The long-term effect of this approach has been a loss of over 30%. Of course, during the great tech bull market of the 1990s sitting out when tech was ‘underperforming” would have meant missing out on some major potential gains. Since the tech bubble burst in 2000, however, the bottom line is that when tech stocks underperform they “really” underperform. Lastly, to fully illustrate the difference in performance by FSPTX when it is leading or lagging the Dow, Figure 5 plots the graphs from Figures 3 and 4 together. As you can see, the difference is quite compelling.
Figure 5: Growth of $1,000 invested in FSPTX when FSPTX is leading the Dow (blue line) versus growth of $1,000 invested in FSPTX when FSPTX is trailing the Dow (red line) since 1989 From what we see here it would appear that a “go with strength” approach definitely appears to have some merit. To put it another way, when the tech stocks are leading the large industrials it is better to be in tech stocks. Conversely, when tech stocks are lagging the big dogs, it is better to simply be in cash.Results – 1989 to Present
Where Are We Now? Figure 6 displays:
Figure 6: Tech stock performance (blue line) versus the 63-day percent rate-of-change for FSPTX minus 63-day rate-of-change for Dow Industrials since December 31, 2007 As you can see the red line was negative for most of the 2008 meltdown and turned sharply positive in 2009, proving a harbinger of a major tech rally. Now the red line is flitting about very close to the zero line (in fact it has ticked into negative territory a couple of days in 2010).Summary The results I’ve presented here are something of a Catch-22. While the technology sector (and by the way, the market as a whole) clearly performs better when technology is leading the way, there is a tremendous amount of volatility involved. While the results displayed in Figures 3 and 5 show good overall returns there are also some nasty drawdowns along the way in the technology sector. Also the “bearish periods” displayed in Figure 4 first witnessed an advance of +260% between the end of 1989 and September of 2000. Still, since that time money invested only during the bearish periods has declined in value by -80%. So perhaps the best use of this particular model is as a “filter” to help keep us on the right side of the overall market, rather than as a mechanical trading model. One other disturbing note worth a mention is the recent sharp run up seen in Figures 3 and 5 in technology stocks, which is eerily reminiscent of the sharp run up during the late '90s into early 2000 “dot-com bubble." Wow, maybe I should have titled this piece “Beware of the Tech Bubble.” Of course no one would have read that article because their first reaction would have been “Tech bubble? What tech bubble?” Sometimes things hide in plain sight. I am not necessarily forecasting another tech bubble burst. I am simply suggesting that you keep a close eye on the performance of tech stocks relative to the performance of the overall market for a potential clue as to where things are headed next. The bottom line, though, is this: if tech heads south, there is a good chance that a whole lot of other stocks will go with it. Hey, have a nice day.
Jay Kaeppel Staff Writer and Author of Seasonal Stock Market Trends Optionetics.com ~ Your Options Education Site Questions for Jay? Please visit "Ask the Traders" through the discussion board on the Optionetics.com home page.
NOTE: Jay’s latest book, Seasonal Stock Market Trends: The Definitive Guide to Calendar-Based Stock Market Investing, was ranked among the Top 10 Investment Books for 2009 by the venerable The Stock Trader’s Almanac 2010. For more info, please click here.
© Copyright 1995-2010 Optionetics. All rights reserved. This material is for personal use only. Republication and re-dissemination, including posting to newsgroups, is expressly prohibited without the prior written consent of Optionetics. Optionetics is a registered trademark of Optionetics, Inc.
Copyright © 1995-2010 Optionetics, Inc. All Rights Reserved
Legal Notices and Disclaimers | Privacy Policy | Refund Policies | Terms and Conditions Non-US Citizens | Chicago Board Options Exchange (CBOE) Disclosure
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