There is much more to the first-quarter drop in the S&P 500 Index than its modest 1.22% decline suggests. Everything from changing narratives in technology stocks to higher asset price correlations reveals a watershed moment for a bull market that has been underway since 2009. That was on display Monday, with the benchmark posting its worst April start since 1929.
Below is a list of what the first quarter taught us about current market dynamics, and how they may inform investor psychology going forward.
1. Too many investors are still overweight technology shares. Large-capitalization U.S. tech stocks were largely a one-way trade from 2010 through 2017, consistently outperforming with low overall market volatility. As a result, a lot of “lazy long” money flowed into the sector. The price action in large-cap tech shares the last few weeks underscores how many weak hands still over-own the sector. Tech insiders have been warning about data privacy and insular managements for several years, yet Facebook’s recent challenges clipped the stock price by almost 20% and hurt overall group performance.
That’s clear evidence of the market’s negative reaction to price momentum rather than the specter of new fundamentals coming to the fore. This means tech stocks will remain volatile amid an uncertain regulatory environment and shifting business models. It should not be as bad as 2000-2002, if only because the group now features real profitability and dominant market share in important segments such as online advertising.
2. Big Tech is not a lean, artificial intelligence-powered black box of endless profits, but rather a messy jumble of hardware, software and lots of much-needed human intervention. Self-driving cars caused a pedestrian fatality. Facebook, Google and others backtracked on their basic investment thesis of offering advertisers an entirely automated system to gather, hold and monetize social attention. Tesla remained woefully short of basic manufacturing skills.
Software may still eat the world, but it is going to have some very bad indigestion along the way. That will — temporarily, at least — ding both risk premiums and terminal values as investors struggle to discount news flow into their valuation frameworks.
3. Volatility may be an absolute measure, but humans perceive it in relative terms. The sleepwalking equity market of 2017 gave way to one with chronic night terrors last quarter. That shift, combined with lofty valuations, has sparked concern that domestic stocks are setting up for a 1987-style crash. The truth is that the first quarter was a normal one for volatility if you exclude recent history from 2010 through 2017. The CBOE Volatility Index, or VIX, closed March at 19.97, right at its long-run average.
Volatility returning to its long-run historical form is healthy, but over the next 90 days it will feel tumultuous.