Trump and Yellen could derail the stock market's hottest trade

Investors in red-hot tech companies are heavily exposed to political risk, and they may not even realize it.

After all, one of the main selling points for tech stocks last year was how disconnected they were from macro drivers. Traders shied away from energy because they were puzzled by oil, and stayed away from financials and utility stocks because of uncertainty around interest rates. This led to investment funds crowding into tech stocks, for lack of better options.

But now, in an ironic twist of fate, tech-heavy investment funds have become beholden to the macro risk that they sought to avoid, says Wells Fargo. The surging popularity of tech stocks - which are up 23% this year, more than double the S&P 500 - have made them a proxy for market risk.

And that's been fine so far this year as traders have chased returns in the industry, which is growing earnings hand over fist. But what's been underappreciated is how much of a boost the sector has gotten from the macro picture - most notably the slow implementation of President Donald Trump's economic agenda and a series of dovish comments from Fed Chair Janet Yellen.

Wells Fargo warns that as soon as these dynamics shift, tech bulls could be in for a rude awakening. They recommend cutting exposure to the industry.

"There seems to be an implicit belief that Yellen and Trump are the gifts that keep giving and it'll only continue," said Christopher Harvey, a senior analyst at the firm. "Fundamental investors are being lulled into a false sense of security. They are failing to appreciate the correlation between 'the macro' and the relative performance of tech. Our recommendation is to reduce portfolio risk by taking some tech profits."

For evidence of this, consider the close correlation between tech performance and a strategy built to bet on a dovish Fed and the ongoing futility of Trump policies. They've traded in close lockstep in 2017, especially in the last few months.

While Wells Fargo thinks the possible downside risk in tech is being ignored to a degree, Bank of America Merrill Lynch has already started to notice flagging enthusiasm around the tech trade.

After reaching a bull market high earlier this year, flows into tech funds have slowed sharply, on a 16-week rolling basis, according to the firm's data.

However, it's important to note that neither Wells Fargo nor BAML are calling for the end of the scorching-hot tech trade - they're simply stressing caution. More than anything, it's hard to argue with the profit expansion being seen in the sector.

Tech stocks are expected to grow earnings by 18% this year, a full six percentage points more than the benchmark S&P 500, according to estimates compiled by Bloomberg.

So even if investors become more aware of the macro risks in the market, it may be difficult for them to turn their back on the wildly successful tech trade, which looks so good on a fundamental basis. And therein lies the critical tug-of-war over what actually drives the market - one that is far from being settled at this point.