September 4, 2020
Thus far, the current sell-off in software stocks looks like episodes from the past two years (2018 and 2019), which also happened to occur in August/September. This current episode is likely to look similar to the past two, rather than a full-fledged correction where multiples are cut in half. Multiples are stretched and positioning is over-crowded, but there’s no fundamental weakness in recent results from software companies. The catalyst for the sell-off was bad guidance from network equipment provider CIEN. As discussed on Wednesday, rising vaccine optimism may also be a headwind for perceived ‘COVID winners’ as incremental investment dollars begin to shop low multiple beneficiaries of ‘return to normal.’ If the current pull-back in software builds into something more severe, investors should avoid high multiple SMID-cap companies with negative operating margins.
The Nasdaq Composite (CCMP) broke initial trend line/upside gap support yesterday when it closed below 11,700. At 11,225, the CCMP is currently trading above more significant technical support defined by its prior break-out at ~11,130 and would still be ok down to its 50-day moving average of ~10,900. At ~3410, the S&P 500 is currently resting right at initial technical support with more significant levels in the 3210-3280 pattern break out range. Levels below technical support would change our mind about the severity of the current pull-back. We’re also keeping a close eye on bond yields with 30-year levels above ~1.60% as a potential trigger for more meaningful sector rotation. The first thought should be that both indices hold support and bond yields stay range bound, which argues for a near term bounce in the SPX and CCMP before possibly testing these same levels again in October (pre-election).