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Last week's tech panic sent most of the so-called FANG stocks - Facebook Inc (NASDAQ: FB ), Amazon.com, Inc. (NASDAQ: AMZN ), Netflix, Inc. (NASDAQ: NFLX ) and Alphabet Inc (NASDAQ: GOOG , NASDAQ:GOOGL) - significantly lower in a very rough trading session.
Other stocks included in the FANG category - Apple Inc. (NASDAQ: AAPL ), Nvidia Corporation (NASDAQ: NVDA ), Adobe Systems Incorporated (NASDAQ: ADBE ), Microsoft Corporation (NASDAQ: MSFT ), etc. - sold off in the frenzy last week as well.
This was a stressful event for traders because large-cap tech stocks have accounted for much of the recent market rally. Prior to the decline, the top-five Big Tech performers had accounted for 40% of the S&P 500's year-to-date gains while only representing 13% of the index.
A small group of stocks leading the S&P 500 isn't unusual. Leadership within the major indices will flip back and forth from one group to the next, and some rallies can be very narrow. For example, the gains in the fourth quarter of 2016 were largely driven by financial stocks. By the end of December, Goldman Sachs Group Inc (NYSE: GS ) accounted for nearly 25% of the gains of the Dow Jones Industrial Average all by itself.
What is important to watch after a group has lost leadership is whether momentum has merely been "handed off" to some other market segment, or if that leadership is quickly reasserted by the same group. In either of those two scenarios, we would assume that the market will bounce back in the short term. However, if neither of those things happen, we should plan on a large drawdown like we saw in the third quarter of 2016.
FANG Stocks Have Some Bite Left
While it is a little early to tell, we think there is some potential for the FANG stocks to reassert their leadership, confirm support and lead another rally. Whether this will take the major indices to new highs is less clear, but it seems likely that prices won't drop by very much.
There are still a few laggards in the FANG group that are a concern. AAPL and NVDA have been downgraded again, and their recoveries have been sluggish. That is worrisome, but it won't necessarily spoil the potential rally.
Part of the reason we are cautiously optimistic about the FANG stocks is the technical support behind the rally. The next chart of Facebook is a very good illustration of what we mean by a "technically supported" bounce.
Facebook (FB): Chart Source - TradingView
When a stock is exhibiting very precise responses to technical triggers, it attracts attention and price movement becomes a nearly self-fulfilling prophecy as volume builds.
Facebook completed a bullish "pipe bottom" pattern on May 17-18, which resulted in a new high the day of the selloff. The May 3 and June 6 highs completed a short-term bearish divergence signal, with a primary target of $144.42, which was reached this Monday and is equal to the pipe bottom's support level.
Subsequently, FB has rallied off its short-term support/target level and may be heading back towards its prior highs. However, there are a few factors that could spoil the rally this month and should be watched closely.
The Federal Open Market Committee (FOMC)
The Federal Reserve raised the shortest-term rate on Wednesday by another 25 basis points. While the hike was widely expected, the accompanying statement was more dovish than we had thought it would be. Does this show a lack of confidence at the official level? How investors read that statement could make a big difference in the short term.
If for any reason the big FANG stocks fail to form new highs, the bullish pattern we see now would shift into a "head-and-shoulders" reversal signal. It is too early to get nervous about such a technical pattern just yet, but it's worth watching.
Over and over again, momentum stocks have rallied up off of their lows in this bull market. It isn't much of a stretch to buy the dips, but traders should be vigilant while inflation expectations remain low. At this point, we believe the most likely implication for the broad market indices is limited downside potential. New highs are certainly possible, but a flat yield curve will make that challenging.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.
John and Wade have now launched Turbo Trader Live - a live, interactive trading room service that focuses on technical analysis, long options and vertical spread strategies to help investors like you lock in fast and consistent profits with less risk.
You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.
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