The DJIA and S&P 500 Slip as Tech Stocks Rise

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Hedging activity has become scarce as small-cap tech takes the lead

The DJIA tumbled 200 points and the S&P 500 fell for the third day in a row as investors quickly got over the passage of the new stimulus bill and backed away from their recent buying spree of value and cyclical stocks. Apple was a notable winner today as reports surfaced that the iPhone maker is entering the electric vehicle market. That put more pressure on shares of Tesla (TSLA), which has not had such a fun two days as part of the S&P 500.

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We are still waiting patiently on the Santa Claus rally, which is usually here by now. But 2020 has been unusual, so we’ll keep waiting. Inside the stock market sector rotation, smaller cap tech stocks have seen a lot of love of late and they are lifting some key ETFs to all-time highs (more below).

Since the vaccine-induced euphoria of a few weeks ago, the major U.S. indexes have basically traded sideways as investors look for the next catalyst. The passage of the stimulus bill was definitely not what they were looking for, but they are poised to push markets higher, and they are apparently not protecting their downside if things go awry given the recent lack of hedging activity.

share price chart

Nobody’s Hedging

The bullish sentiment that is swarming the worldwide equity markets is also blatantly evident in the options market as well. Hedging activity, when traders or investors take an offsetting position in a security with the intention of reducing the risk of adverse price movements, has become extremely scarce. Normally, a hedge consists of taking an offsetting position in a related security.

According to SentimenTrader, the Equity Hedging Index (EHI) (That’s a new one for me…) is now in the lowest 6% of all readings since 1986. The EHI looks at the most common ways an investor would hedge their portfolio. The more each indicator shows hedging activity, the higher the EHI will be; the lower the EHI, the less hedging is happening.

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So What?

Like a lot of the bullish indicators we have been sharing lately, the EHI can be a contrarian indicator. The lower it goes, the more likely asset prices will fall in the near term. It’s the “Be fearful when others are greedy, and be greedy when others are fearful,” Warren Buffett axiom at play.

According to SentimenTrader, historical trends since 1986 have shown that when the EHI is below 21, the S&P 500’s annualized return has been -2.4%, versus +49.8% when the EHI is above 85, suggesting a higher probability of lower returns now given the current reading of the indicator.

Equity Hedging Index
Image courtesy SentimenTrader.

Rotation Nation

We’ve been talking about the rotation from growth to value stocks over the past month as investors have bet on a recovery. That has led to a consolidation of the mega-cap tech stocks that led the market out of its lows last April. Of the FAANG stocks, only Apple (AAPL) and Netflix (NFLX) have gains of over 8% in that time. Facebook (FB), Alphabet (GOOGL), and Amazon (AMZN) have been relatively flat as the overall market has pushed higher.

But tech investors have not abandoned the sector entirely. As JC Parets of All Star Charts points out, the sub-industry groups around technology have all pushed higher. The Internet, semiconductors (except for Intel (INTC)), cloud computing, and cybersecurity stocks all continue to make new highs. Money is flowing down the cap scale inside the technology sector, and share prices and ETFs that track those sectors like XSD, HACK, XWEB and SKYY are all at or near all-time highs.

Market Cap Rotation
Chart courtesy AllStarCharts.com.

What Are the Rich Worried About?

The pandemic has caused many people to have concerns about their finances —

including Americans with investable assets between $100,000 and $1 million. According to Bank of America’s survey of affluent Americans, half of respondents have a more pessimistic outlook on the economy than they did at the beginning of the year. Moreover, at least a third of them are up at night worried about economic setbacks, unexpected increases to healthcare expenses, and uncertainties making it difficult to plan for the future.

What Are They Doing About It?

Nearly half of those surveyed said they are using this time to get their finances in order, with more than a third saying they are optimizing or actively managing their finances more often.

Affluent Americans are also saving more, with 80% of respondents taking the money they normally spend on entertainment, travel, and dining to put into savings accounts and emergency funds.

And what do they miss most about pre-pandemic life? The food. When life returns to “normal,” affluent Americans plan to spend more on grocery delivery (30%), food prep and meal kits (27%), and restaurant delivery (26%).

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