Tech stocks are facing a roadblock, and the market can't afford for them to stumble

May 31, 2017

Tech stocks are facing a roadblock, and the market can't afford for them to stumble

Tech stocks are their own worst enemy.

After a five-month stretch that's seen their share prices soar 17%, beating the broader market by two-fold, the group now faces one of its biggest challenges yet: Breaking through technical levels established by historical trading.

The Technology Select Sector Index is about to test an upside resistance level that represents the upper boundary of a trading range that's held since the start of the bull market in 2009, according to Raymond James. It's been unsuccessful in breaching that level over the past eight years, which raises some questions about continued gains.

Technology bull market chart

"It would not be surprising to see some profit-taking as it gets closer to that resistance line," Andrew Adams, a market strategist at Raymond James, wrote in a client note. "We still like technology on a long-term basis, but you may want to hold off on major investments in the sector in case it does pull back, which would not be surprising given how extended it is."

What happens next with the sector has big implications for the rest of the S&P 500, which has clung to the coattails of the tech rally this year as optimism around presidential policy initiatives has faded.

Of particular interest to investors will be the performance of mega-cap tech titans Apple, Facebook, Amazon, Microsoft, and Google. Already massively influential due to their sheer size, the five companies have seen their importance to the ongoing S&P 500 rally amplified as 2017 has progressed. They're now more responsible for the benchmark's performance than at any point this year:

S&P tech influence

But even if tech stocks fail to break through the upside resistance level, it would hardly be enough to derail the longer-term rally — at least if past tests are any indication. The Technology Select Sector index fell slightly after getting near the upper boundary in late 2014 and again in early 2015. After brief pullbacks, the gauge continued higher to the levels seen today.

Bank of America is on board with more gains. In a client note on Wednesday, the firm recommended investors position themselves for a "tech overshoot," while also warning against speculation getting too overextended.

Benjamin Bowler, head of global equity derivatives research at Bank of America, wrote in a client note that investors should specifically look to employ stock replacement strategies, or six-month bullish options contracts betting on the continued outperformance of the tech sector's biggest stocks versus the S&P 500.

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