On Wednesday, November 29th, the market threw a curve at people that were overloaded in technology stocks. Tech stocks were hammered as investors rotated out of these stocks and moved into Consumer Discretionary and Financials. Some tech stocks with great fundamentals dropped more than 10% as the negative mood swept through the whole sector.
How does an investor handle this?
A knee-jerk reaction would be to jettison the stocks, join the stampede and lick your wounds (how many metaphors can I get in there?). Maybe that investor would have spared themselves the final 1-2% of the route, but the damage was already mostly done by the time that the sell order hits.
So in a sector rotation play, there are three immediate questions to ask:
1. Understand why the sector rotation began: Are the reasons legitimate? Is it an overreaction?
2. Revisit why the investments were made in this sector in the first place: Does the investment thesis still hold up?
3. Examine any changes to the sector: Are there macro changes that could impact the sector?
Let’s tee up what happened on Wednesday. There seemed to be two news items that triggered the run on techs. The first was that Autodesk reported disappointing earnings, and the second was that there could be changes to the FIFO/LIFO tax treatment of stock holdings.
How should investors react to Wednesday’s sector rotation using these three questions?
Question 1: Are the reasons for the rotation legitimate? In this case, neither of the triggers should have long term implications for the technology sector. Autodesk is only one company out of a sector that has had a blowout earnings quarter. In terms of the potential tax changes, it might cause some discomfort, but ultimately this should not impact tech stock values.
Question 2: Revisit why the investment was made. The tech sector fundamentals are still in place, and nothing has really shaken the outlook.
Question 3: Any macro changes? None that I can see.
So if these are the answers, then it may make sense to ignore the selloff, hold on to the investments.
Remember, the market often overreacts, and then corrects. Remember this the next time your portfolio falls victim to sector rotation. In the case of the Techs, it has pulled back 1% of the drop today. If, on the other hand, there are fundamental forces that are changing the outlook of this sector, a reassessment is in order, and it may be time to act.