The stock market is flashing some terrifying parallels to the tech bubble - and it could be foreshadowing a painful crash to come
- The stock market has struggled lately, leaving investors wondering how bad the selling can get.
- The Leuthold Group sees parallels forming between current trading conditions and the period around the tech bubble. The firm warns against even deeper losses, especially in the formerly beloved tech sector.
In terms of stock market health, it's a pretty good rule of thumb that as soon as conditions start to resemble the dot-com era, it's time to get worried.
The Leuthold Group has been closely watching one metric that's been showing some tech-bubble characteristics, and the signals it's flashing aren't pretty.
Leuthold is specifically looking at what it refers to as the Popular/Panned (PP) ratio, which looks at the performance of tech stocks (the popular group) relative to utilities (the panned area).
As the chart below shows, the current PP ratio's last seven years closely sync up with the same measure leading up to the dot-com reckoning. And, as you can see, there's much more pain in store for the market's favorite stocks if this pattern continues.
"The character of the contemporary period is rhyming enough with a past era to at least pay attention as to how this may play out," Jim Paulsen, Leuthold's chief investment strategist, wrote in a recent client note.
How bad could it get? Paulsen estimates that if the PP ratio falls to the same extent it did during the dot-com bubble meltdown, and if utility stocks remain flat, the tech cohort could fall an additional 25%. That would drag those stocks down to a level not seen since 2016.
That's troubling news for a stock market that's already been devastated by selling. In recent weeks, trusted bull market favorites have plunged, which has erased year-to-date gains for all major US indexes and sent them into corrections.
And it's not exactly like investors can rely on their old bag of tricks to dig themselves out of this market mess. According to experts, the previously unassailable strategy of buying the dip has been exhausted, leaving equities without a valuable psychological safety net. In fact, Morgan Stanley has gone as far as to recommend traders do the opposite: sell any rallies.
As if that wasn't discouraging enough, some market pundits have declared that recent market selling is simply setting the table for a far more drastic collapse next year.
One prudent way to play this emerging dynamic could be to lean into the trend, and sell tech stocks in favor of utilities. Of course, if the current PP ratio eventually stops mirroring its dot-com-era counterpart at any point, all bets will be off.
This would seem to be the new normal for the market. Strategies that have worked for years are now duds, and many participants are scrambling to handle a suddenly volatile environment. In the end, the PP ratio is just one metric investors should be watching to make sense of it all.