After the Dow crossed 29,000 for the first time since February, U.S. stocks have fallen sharply in September, hitting two-week lows as technology (tech) company valuations are being scrutinized. After reaching lows in March, we saw markets recover sharply — the S&P 500 Index returned almost 60% through the end of August (since March 23, 2020). However, this rally had been very concentrated with the top five stocks in the tech sector (Apple, Amazon, Microsoft, Facebook, Google and Nvidia) contributing to about 34% of the move.

As we have noted in the past, tech sector valuations have gotten significantly stretched as they benefited from people staying at home and practicing social distancing. The rise was further supported by an increase in day trading by retail investors who have bid up prices of not only high-quality tech companies like Apple and Microsoft, but have also caused a significant increase in valuations for companies with less impressive balance sheets and cash flows like Tesla, Nikola and others.

So, what’s going on today?

We are beginning to see a rotation out of the tech sector into more cyclical sectors like Financials and Industrials. Traditionally – defensive sectors such as Utilities, Real Estate and Staples, have also started to outperform. Over the last three days, the Nasdaq Composite, which is heavy on technology stocks, has fallen about 10% while the S&P 500 and Dow have lost about 5%. We are also seeing flight to safety with 10-year bond yields falling to 0.66% and the U.S. dollar strengthening. We believe that if we continue to see cyclical sectors like Financials and Industrials outperforming Tech, it will bode well for the overall U.S. stock markets implying wider market participation.

This most recent sell-off seems to stem from both profit taking and concerns related to a disconnect between the tech sector’s boosted stocks and investor sentiment. The Financial Times reported that SoftBank bought billions of dollars in tech derivatives ahead of the shift that began on Thursday, which are likely amplifying the losses. Tesla, which has tripled since March, is down 15% today after it was passed over for inclusion in the S&P 500 Index, which many investors had bet would give the shares another lift.

We have been pleased with the performance in Select Equity through this environment, and our commitment to managing downside risk is helping to shield the portfolio. Utilizing 16% sector limits has proven beneficial, especially in the past three days. As COVID-19 cases continue to decrease and with a vaccine on the horizon, we expect a rotation to Financials and Consumer Discretionary, supporting our thesis on being overweight the consumer.