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Nasdaq falls 2.6% as investors take profits in technology stocks

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. – Warren Buffett

The recent strong momentum in technology stocks came to an abrupt halt last week as the Nasdaq Composite Index dropped 2.6%, making it the worst performing major stock average. By almost any measure, valuations of technology stocks have become stretched and investors decided to take profits in what has been the best performing sector of the market this year. The most crowded trade has been in the so-called FANG stocks that include Facebook, Amazon, Netflix and Google (Alphabet) as these stocks have been popular holdings of fund managers. What may have sparked the selling were executives from social media giants Facebook and Twitter providing testimony before Congress. Concerns have increased recently that technology companies may be hurting competition and inhibiting a free exchange of ideas on their platforms, which could result in government regulation. Such talk provided investors with a convenient excuse to sell their winners and redeploy the proceeds in other sectors of the market that have underperformed. Trade tensions also continued to hang over the market as no agreement was reached between the U.S. and Canada and President Trump threatened China with a new round of tariffs on $267,000 billion of Chinese goods. While many of Trump’s economic policies are benefiting the U.S., they are doing so at the expense of overseas economies. As the Federal Reserve tightens monetary policy and the value of the dollar rises, emerging markets have been under pressure and their stocks have been weak. It may take longer for emerging markets to bounce back, but technology stocks could reemerge as the best performing sector into year-end. Nevertheless, it is prudent to reduce exposure to riskier areas of the market in favor of a more defensive approach that emphasizes stocks with lower volatility.

Last Week

The employment report for August showed that 210,000 new jobs were created compared to an estimate of about 190,000 and the unemployment rate remained at 3.9%. Average hourly earnings were higher than expected and posted the highest wage growth since April 2009. The increase probably solidifies two additional interest rate hikes this year (September and December). The ISM manufacturing index in August was better than expected and at the highest level since May 2004 while the ISM non-manufacturing or services sector index was also strong and better than expected.

For the week, the Dow Jones Industrial Average slipped 0.2% to close at 25,916 and the S&P 500 Index fell 1.0% to close at 2,871. The Nasdaq Composite Index dropped 2.6% to close at 7,902.

This Week

Both the core producer price index (PPI) and consumer price index (CPI) for August are expected to increase modestly and match the year over year increase recorded in July. Import prices in August are expected to edge only slightly higher. August retail sales are forecast to post a healthy increase as consumer spending remains strong. The University of Michigan consumer sentiment index for September should remain at the same high level that it was in August.

Only a handful of companies report quarterly earnings this week and the most notable among them are Wageworks, Kroger, Oracle and Adobe Systems.

Portfolio Strategy

Being underweight technology stocks this year has hurt the performance of many value-oriented funds, including the S&P 500 Dividend Aristocrats Index. Companies within this index have consistently increased their dividends for at least 20 consecutive years. The reason why dividend growth stocks in this index have underperformed the S&P 500 Index this year is the lack of technology exposure. Until recently, most technology companies haven’t paid a dividend let alone raised their dividend for 20 consecutive years.  Instead, these companies reinvested profits that would otherwise be paid in dividends to shareholders back in their businesses to fund future growth. Two funds that invest in dividend growth companies using the Dividend Aristocrats Index are the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) and the SPDR S&P Dividend ETF (SDY). Both of these exchange traded funds have the same investment objective of capital growth and dividend income and both ETFs have a current yield of 2.6%, compared to a yield of only 1.7% for the S&P 500 Index. The majority of stocks in the fund are large cap and they tend to be a mix of both value and growth stocks. Average sales and earnings growth of companies in the Aristocrats Index have also been on a par with those in the S&P 500 Index. While both NOBL and SDY have underperformed the S&P 500 this year, NOBL has outperformed this benchmark since its inception back in 2005. Both funds tend to be more defensive and less volatile than the S&P 500 and should provide investors with a smoother ride over the long term.