Tech Wreck vs. Dreck: Why It's Different This Time

 | Aug 04, 2017 | 1:00 PM EDT
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Dreck (or drek, depending on how far back you want to trace the root of the word), is a word that has become associated with filth, rubbish, trash and other substandard conditions. While the market crash from the 2000 peak to the 2002 low is widely known as the Tech Wreck, after the Nasdaq 100 fell 82% during that slide, the current environment's eerie similarities beg the question, "It's different this time?"

Just putting those words in that order causes many market veterans to shiver, as they are considered the four most dangerous words in investing. Why? Because they only come to the crowd's consciousness when the answer is soon to be rediscovered as an emphatic no. That is, it's never different this time.

The only scenario where things could be different would be if, and only if, market participants ceased to be human. Otherwise, humans will always act with humanness -- emotionally buying as prices rise (especially to all-time extremes) and emotionally selling as prices fall (especially to all-time lows). Recently, some humans argue that the infiltration of artificial intelligence (AI) into the markets has changed the playing field, and it could be different this time. However, this rationalization is just the newest in a long history of rationalizations about other "turning points," where the playing field was thought to have changed.

For example, into the 2000 peak, a handful of tech titans saw their valuations nearly double in the final few years of the bull market ending in March of that year. The rationalization then was that the internet had changed everything, and the old valuation models were useless. Currently, another handful of tech titans have recently seen their valuations nearly double in the past few years of the bull market off the 2009 crash low. This time, the rationalizations include the internet, social media, the cloud, AI, etc.

Below is the monthly bar chart of the Technology Select Sector Fund (XLK) , showing the rise into the 2000 peak, the spectacular Tech Wreck and the 17-year return to the former price high. While prices are at all-time highs (approximately 8% higher), history shows that the final moments of an aging bull market are rarely worth playing, and more often than not result not only in little marginal gains, but also in becoming trapped in a fully invested portfolio at the exact time one should be reducing risk and raising cash.

July data from the American Association of Individual Investors show that the crowd now holds less than 15% portfolio cash, the lowest level since January 2000; the month the Dow peaked, before the S&P and Nasdaq peaked in March.

Technology Select Sector Fund (XLK) -- Monthly

Is it different this time? It sure is. With an equally fully invested crowd, the financial system is geometrically more leveraged. Not only with the inconceivable $500 trillion in derivatives, but also after the Federal Reserve just expanded its balance sheet fourfold to nearly $5 trillion. Meanwhile, more of the public is on food stamps, huge numbers of people have permanently left the job market, and under-funded pensions threaten to impoverish millions of retirees in the coming decade as the number of states unable to pay their obligations could reach Depression-era levels. Is it different this time? It sure is.

Yet, as prices rise, pundit calls for the most speculative stocks and asset class to move parabolic are abundant. Bitcoins, the greatest frenzy since the tulip bulb mania, have just been forecast to reach $100,000 in the near future. Historically, the greatest companies, too, reach exuberant overvaluations during the blow-off stage of manias. This is how the XLK crashed 79% in the Tech Wreck, and the NDX (100 largest stocks in the Nasdaq Composite) crashed 82%.

What's coming next is likely to be worse: the Tech Dreck. It doesn't matter what the FANGs do for their businesses, just as it didn't matter what the handful of leaders did in 2000. When that bubble burst, everything became rubbish, and even the best names like Cisco (CSCO) , Intel (INTC) , GE (GE) , Microsoft (MSFT) , Dell, Qualcomm (QCOM) , etc., were thought of as filth in 2002.

Reviewing the handful of current darlings, a.k.a. Facebook (FB) , Amazon (AMZN) , Apple (AAPL) , Netflix (NFLX) and Google (Alphabet) (GOOGL) , we can see huge reversals in Amazon and Google, which are the current canaries in the coal mine. These reversals should be considered the shots across the bow, warning investors to turn their ships of epic long market exposure (especially if on margin) to a more conservative course (i.e., take all margined shares off the table, and take as much of other long exposure off the table you're not willing to expose to another 17-year, or greater, "round trip" like the one from 2000 to now). (Facebook, Apple and Alphabet are part of TheStreet's Action Alerts PLUS portfolio.)

Other considerations? How about last week's lowest VIX (fear index) ever recorded? This shows the crowd has never, ever been more confident that stocks can only rise. Really? Isn't the time to adopt that certainty after stocks have crashed, rather than risen out of the most recent crash?

Circling back to the XLK, with the potential to decline into the middle of the green buy zone, the center of which surrounds $31, from the current middle of the pink sell zone of $57, this 45% "minimum expectation," even if $62 is seen first, the objective message of the market must be concluded to be that this is not the time to be overly long.

Imagine how bad you'll feel, especially if you stayed too long at the 2007 and 2000 parties, if another near-50% wipeout fools the crowd ... again! Instead, say thanks, give thanks, and squirrel away as much money as you don't want to lose half of in the coming three to five years of extraordinary risk. Then, around 2020, start putting some of the sidelined money back into risk assets, and be fully invested by the end of 2021. The only thing you have to lose in this plan is potential profits, rather than actual profits and actual capital if you stay fully invested in the similar market condition that has resulted in the two greatest market crashes in the past three decades.

Finally, remember the Wall Street adage, "It's better to be out of the market, wishing you were in, than in the market, wishing you were out." 

For updates on this analysis, as well as other trading opportunities, try Ken Goldberg's DSE Alerts service for free for a couple of weeks, or contact him at 

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