The tech-heavy Nasdaq 100 Index is showing serious signs of overheating, an indication that a selloff might be right around the corner.
After surging 10% in the past month, the benchmark—home of the likes of Apple Inc., Amazon.com Inc. and Microsoft Corp.—has seen its relative strength indicator, a 0-100 gauge of bullish and bearish price momentum, soar to 78, well into overbought territory. That’s seen by traders as a contrarian signal that a decline is imminent, because buying has gotten excessive. Four of the last five times the indicator hit such a level, the Nasdaq 100 shed 12% or more to the ensuing low.
The latest leg of the rally has been fueled by a string of solid earnings from technology companies and the Federal Reserve’s dovish messaging on rate hikes, helping the index beat the S&P 500 by more than three percentage points since the reporting season began in mid-October. But the outperformance can’t go on forever.
“It would be better if this index took a breather,” said Matt Maley, chief market strategist at Miller Tabak & Co. “It would actually help the tech sector rally further into the end of the year.”
In first signs of pullback, the Nasdaq 100 fell Monday for the first time in 11 sessions, snapping the longest winning streak since December 2020. Investors, however, were quick to turn bullish again, with Nasdaq 100 futures pointing to a positive open on Tuesday. Nvidia Corp. is once again outperforming its tech peers by a large margin, rising 5.6% in U.S. premarket trading.
“The biggest drivers of the Nasdaq 100 performance over the last month have really been concentrated in a few high performing stocks, which is notable,” said Chris Berthe, global co-head of cash equities trading at JPMorgan. Indeed, in the past month, Tesla Inc. and Nvidia were among the biggest gainers, adding several hundred billions of dollars in market value.
The move in the futures on Tuesday serves as a reminder that it’s not a given that the benchmark is headed for a double-digit decline, because it can stay at overbought levels for a long period, as in early 2020.
What’s more, Citigroup Inc. strategists say the positioning on Nasdaq future contracts appeared more balanced after a chunk of bearish calls were unwound last week. “However, pockets of risk remain,” strategists led by Chris Montagu wrote in a note.
There’s plenty of news that can help turn sentiment against the tech sector broadly: China’s regulatory crackdown is ongoing, and there are growing signs that companies that benefited from pandemic lockdowns now are suffering as economies reopen.
Monday’s rally in Chinese after-school tutoring stocks, spurred by a report that Beijing will issue new licenses, didn’t last long, signaling that investors expect China’s regulatory efforts have further to run.