Game Over for Tech Stocks II

On Monday, I wrote about the big sell-off we saw for tech stocks last Friday, June 9. I’m going to carry on with that discussion because there’s a lot at play, and this could be a pivotal few days for the stock market. 

One thing I brought up Monday was “distribution days.” This concept needs some more attention. Oftentimes, before a stock has an upside break in price, you will see several individual days where the price rose on much higher than average volume. These are called “accumulation” days. And they are usually thought to mean that some big players are getting positioned. 

Accumulation days are often punctuated by several days of selling, but on very low volume. If we look at a chart of Apple over the last year, we can see that a lot of buying took place last year when the stock was between $95 and $105. You see that most of the big volume days were up days. This is big money getting positioned ahead of a big move in price.

Now that Apple has been at all-time highs, the picture seems to changing. Three of the last four heavy volume days were down days. These are distribution days. They mean those big buyers last year (and early this year) are selling, distributing the shares they bought.

If we look at the Nasdaq as a whole, we can see a similar thing.

When you see selling on heavy volume like this, it’s a sign of conviction. That is, investors are in “sell first, ask questions later” mode.

Now, it’s true that the game plan for this market has been “buy the dips.” It’s been that way for years. But it’s gotten a bit reckless since the election. Investors barely wait two days after a decline before bidding stock prices to new highs. 

This will change at some point. One of these sell-offs will continue, and the “buy the dip” crowd will get a painful beatdown. 

Is that what’s happening now? I can’t tell you for sure that we are headed into a correction. But I do see a pretty good reason to think that’s what’s happening. 

Buyer’s Strike

Last week, Morgan Stanley put out a research note calling for a buyer’s strike for new cars. 

Car sales have been one of the bright spots of the economic recovery. In 2016, a record 17.55 million cars were sold. But automakers have gone to some pretty extreme measures to get those sales. Loan terms now get pushed out as far as six years. There’s now around $1.2 trillion in auto loans out there, nearly 22% of which are subprime loans. 

Delinquencies on subprime loans have been on the rise. And lenders are making less of these loans. That right there suggests car sales will go down. But there are a couple other factors at work. 

For one, used car prices are falling. That makes used cars more attractive. But it also means people get less for trade-ins. So that new car will be more expensive. 

And two, there are massive inventory builds going on. Back in May, there were 145,763 2016 model year cars for sale. Today, the number has fallen to 112,310. It will take another two and a half months to clear that inventory. Then they can start working on the 2017 models. 

You can probably see where this is going. Ford has already lowered its sales numbers going forward. Morgan Stanley cut its auto sales forecast this year to 17.3 million, down from 18.3 million. It lowered estimates for 2019 and 2020 down to 15 million each.

Those are pretty big revisions. And I think it’s clear that automakers will have to slow production down in order to adjust the current state of demand. That means layoffs…

The Vicious Cycle

So, you may be wondering what auto sales have to do with tech stocks. Not much, really. But in terms of the “stock market story,” auto sales are very relevant. 

The story has been that falling unemployment will eventually lead to higher wages and more spending. That’s what will break the economy out of its 2% GDP growth funk. 

Investors have even looked past Fed interest rate hikes, taking them as a sign that wage inflation is right around the corner. But the outlook for car sales is troubling. 

The last thing this economy needs is for consumers to start spending less and for unemployment numbers to start ticking up. This is the vicious cycle of recession. Spending stalls, people lose jobs, spending stalls more, and suddenly the economy is shrinking.

I think this is why tech stocks have dropped so sharply.

It’s no secret that as a bull market rolls on, investors take on more risk because everything looks hunky-dory. So they buy high-price momentum names like Tesla or Netflix. Of course, they know deep down that these stocks carry risk and may be overvalued. That’s why they are the first to get sold when there’s trouble brewing.

I think we’re about to start seeing the economic data get weak. And I think we are on the brink of a true 10% correction for stocks. So tread carefully this summer.

Until next time,

Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.