Apple’s China Troubles Catch Fund Managers Chasing Rally

For months, megacap tech shares powered US stocks to dizzying gains. The market’s engine is now starting to sputter.

(Bloomberg) — For months, megacap tech shares powered US stocks to dizzying gains. The market’s engine is now starting to sputter.

The latest sign of trouble came from Apple Inc., where reports that China plans to expand a ban on the use of iPhones in some government agencies sent shares to the worst two-day drop in a month. Apple suppliers such as Qualcomm Inc. and Skyworks Solutions Inc. sank more than 7% Thursday, while Microsoft Corp. and Nvidia Corp. remained under pressure.

The timing could hardly be worse for fund managers who turned bullish on megacap tech in recent weeks, tilting their portfolios harder toward the seven biggest companies, including Amazon.com Inc. and Alphabet Inc. That could rob the market of dip buyers looking to make up ground. At the same time, the hysteria over artificial intelligence applications is abating and the Federal Reserve signaled it remains bent on keeping rates elevated.

“Where tech goes is going to be where the US equity market goes,” said Greg Boutle, head of US equity and derivative strategy at BNP Paribas. “Tech has shown such strong leadership that if it rolls over, it’s going to be very, very challenging for the market to perform.”

Excitement over AI and signs the Fed was nearing the end of its tightening cycle drove the Nasdaq 100 to a 39% gain in the first half of the year. But the backdrop has turned less friendly, with rising Treasury yields among the threats to the group’s sky-high valuations. The tech-heavy index is virtually flat so far in the third quarter after dropping 0.7% on Thursday. Apple fell 2.9% for a two-day slide of more than 6%.

That’s not to say tech’s run is doomed. The group boasts rock-solid balance sheets, while growth in both earnings and revenue is expected to outpace the overall market next year, according to data compiled by Bloomberg Intelligence. And fund managers who missed the first-half rally have been reliable buyers at any sign of weakness.

But the degree of concentration in positioning has intensified. Investors are the most overweight they’ve been on tech since December 2021, according to a Bank of America fund manager survey, and 60% of respondents view being long big tech as the most crowded trade.

A BofA analysis of second-quarter filings shows that a fifth of funds had more than 40% of their assets in the seven biggest tech names. The seven accounted for 29% of active funds’ weight in S&P 500 companies, 150 basis points higher than their weight in the index, according to Savita Subramanian, BofA’s head of US equity and quantitative strategy.

Keith Lerner, co-chief investment officer at Truist Advisory Services, said long-term bets on tech make sense, but crowding and other near-term concerns had caused him to recently turn neutral on the sector.

“The positioning in tech means that expectations are high and it will be hard to find the next marginal buyer, especially since there’s already been a big move and it isn’t apparent what the next upside catalysts will be,” he said. “If recent buyers were just chasing performance, you could see them reverse pretty quickly if there’s any warning sign.”

Valuations also leave little room for error. The Nasdaq 100 trades at 24 times estimated earnings, above its 10-year average of 21, while Apple, Microsoft, and Nvidia all trade at premiums to both their own history and the market overall.

UBS Global Wealth Management said last week that relative to the multiple of the S&P 500 Index, the tech sector’s price-to-earnings ratio stands at “its highest level since the global financial crisis.”

That has amplified the implications of the trouble at Apple, where the two-day rout wiped out almost $200 billion in market value from the world’s most valuable company.

“When the largest company is facing restrictions in a major economy, that is a giant headwind, and it should force investors to reassess valuations,” said Steve Sosnick, chief strategist at Interactive Brokers.

“The reason I’m so generally cautious is that investors are already overweight on tech, and for it to outperform further, they would need to further increase their weighting,” he said. “Given how much multiples have risen, it is more likely they cut their weighting, which would mean a lot of selling pressure.”

The Nasdaq’s 2023 rally stalled out on July 18, 4.4% below its record from November 2021. It’s down almost 4% since then — and there’s more to blame than just Apple.

The bet that AI would continue driving prices higher faltered after Nvidia’s latest results last month. While the chipmaker delivered another blowout revenue forecast, the stock ended little changed and the broader market swooned.

Morgan Stanley’s Michael Wilson, a noted equity bear, told Bloomberg Radio that this was “another negative technical signal that the rally is exhausted.”