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  • Technology stocks have performed poorly.
  • Nobody expects them to rally.
  • The SPDR Technology ETF traded 18% below its 200-DMA earlier this month, a relatively extreme level.

The post-COVID technology stock bubble began deflating last year when names like META Platforms  (META) , Amazon  (AMZN) , and Apple  (AAPL)  made highs in the fourth quarter. Returns across the technology spectrum, from semiconductors to cloud software stocks, have been lousy ever since. 

The Technology Select Sector SPDR ETF  (XLK)  is down about 30% from its December peak. Many stocks are down by far more than that, though. For example, software stocks have been especially hard hit. The iShares Expanded Tech-Software Sector ETF  (IGV)  has declined 42%, and the Global X Cloud Computing ETF  (CLOU)  is down 50%. 

The primary trend for technology stocks remains lower, given those sector ETFs are still trading below downtrending 200-day moving averages. Nevertheless, we’ve seen multiple significant rallies within technology during this bear market, and it wouldn’t be surprising if we see another move up soon.

Is a technology rally on deck?

Yesterday, I wrote about how the U.S. Dollar and Treasury yields provide insight into the next move for stocks. Today, I want to highlight technology stocks because they could bounce substantially higher if the Dollar and yields cooperate.

In Doug Kass’ Real Money Pro daily diary, he wrote a piece today entitled “Walt's Wit and Wisdom - Why the Case of GM and the Fable of the Fishing Boat May Apply to Tech Stocks Today.”

Kass explains why he’s starting to nibble on technology stocks, increasing his exposure to about 7% net long. He writes:

“Throughout 2022, I have avoided the carnage in tech stocks - which I thought were overvalued and were subject to a multiple reset lower based on higher interest rates and a "pull forward" to earnings…Over the last ten days to two weeks - and for the first time in over a year - I have slowly initiated a small position in tech stocks…I have been slowly adding to QQQ, PINS, and AMZN - and I am up to about a 7% net long exposure in technology: QQQ, META, MSFT GOOGL, PINS, and AMZN…I am very close to making the decision of moving up to a 10% weighting.”

Previously, I’ve written about why Kass has begun tilting market exposure bullish. Still, his increasing optimism for technology is particularly intriguing, given he’s only dabbled in them during prior bear market inflection points this year.

The reason for his increasing interest in the basket is similar to why he's generally become more optimistic about the market. Specifically, Kass recognizes that when the masses tilt so far one way that they’ll go to extremes to ignore opposing arguments, it’s usually a sign that mean reversion is likely. In this case, overt – dare we say – overly confident – bearishness sets the stage for a contra-trend rally because nobody believes it will happen.

Kass shares two anecdotes from his former co-worker, long-time Putnam technical analyst Walter Deemer, to explain his position.

He writes:

“My favorite story about Walt was back in 1975 when General Motors (GM) cut its dividend, and two of Putnam's portfolio managers, in total panic, wanted to sell the stock. In fact, they were apoplectic after the announcement. Walt, a man of dry wit and strong technical moorings, remarked in the halls of Putnam that morning (repeatedly so that all could hear), "I'm glad General Motors stock didn't go down in vain."...

Walt turned out to be very right about General Motors' shares. (He usually turned out right!) After the dividend cut, the shares subsequently doubled in 1975 and added another 47% in 1976.”

The second anecdote refers to a letter by Deemer in 1978 warning Putnam’s managers not to ignore conflicting signals or opinions.

To paraphrase Deemer’s memo, fishermen out at sea continuously convince themselves to ignore signs of an approaching and dangerous storm, eventually tossing their barometer overboard to resolve the disconnect between their desire to keep fishing and what the instrument is telling them. Unsurprisingly, that decision didn’t end well for them!

Back to Kass:

“Tech stocks have had a dramatic decline in share price over the last 12 months. Like Wally Deemer's General Motors and Fishing Boat stories, the share price of tech stocks, in general, and of social media stocks have not fallen in vain…

Bull markets are borne out of bad news…With the recent share price declines, an unusually positive upside reward vs. downside risk has likely emerged - and I am opportunistically raising my tech exposure now…

Warren Buffett once famously said, "Price is what you pay, value is what you get."...Skate to where the puck is going and not to where it has been.”

Kass, a self-described contrarian with a calculator, tilts against the crowd to find returns. Therefore, his interest in buying technology stocks now, when they're widely unloved, dovetails perfectly with his style. Admittedly, there’s no telling what happens next, but I think you can argue bearishness on technology stocks is a bit over-stretched.

For example, the following chart shows the SPDR Select Technology XLK ETF price relative to its 200-day moving average.

CHART-Tech-Stocks-102122

As you can see, it’s currently trading 14.5% below its 200-DMA, an improvement from -18.6% below on October 12th. For perspective, the XLK was 20.2% below its 200-DMA at the bottom in mid-June, 16.5% below it at the March 2020 lows, and -16.9% below when stocks made their lows in December 2018.

Of course, it could get worse. We saw lower levels during the Internet Bust and Great Financial Crisis. Nevertheless, this metric appears stretched enough to suggest that, at a minimum, we could get a rally.

How long it lasts? Well, that's anybody's guess.

The Smart Play

Kass provides a laundry list of technology stocks he’s nibbling on in his diary entry (see above), so if you’re interested in buying some shares, you can start there. However, if you prefer to avoid single-stock risk, you could buy a starter position in the XLK, or if you want more growth stocks, the NASDAQ 100 (QQQ) because it’s weighted heavily toward large technology companies.

Remember, though, Kass is still mostly cash, and he’s only tilted net long. As I previously wrote, he’s been running about 75% in cash this year, and even with his bullish tilt, he’s still only talking about being 10% net long in technology. So, perhaps considering this a ‘dip toes’ contrarian bet is best.

In case you’re wrong and technology stocks keep falling, keep your position size small, and use a stop loss. If you buy the XLK, for example, you could put your stop loss below the 21-day moving average, which is about $121, or if you want to give it more room, beneath its mid-October low of $112.97.

Keeping your position size small and using a stop loss limits your capital at risk. For example, suppose you start with a 1% weighting; using the lower of the two stop loss points, you’d risk a loss of about 9% on the XLK. So, you’d only lose 0.09% of your capital if you get stopped out. 

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