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Here’s the big question about the tech tumble

  • Any significant damage to the tech stocks will have an effect on overall investor confidence.
  • On a more structural level, we also believe that the issue of leverage will have an impact.
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Jennifer S. Altman | Bloomberg | Getty Images

Tech stocks are tanking, but the rest of the market is holding up. The big question now is how long this trend can continue.

Friday was a brutal session for tech stocks, and the selling was quite concentrated in a few particular names. The Nasdaq composite fell 1.8 percent, and the Nasdaq 100 dropped 2.4 percent. Yet the S&P 500 fell barely at all and the Dow Jones industrial average actually closed at a record high.

On Monday, we're seeing a moderate version of that same trend, as the Nasdaq 100 drops by 0.6 percent, while the S&P 500 is off by just about 0.2 percent. Of course, for context, the Nasdaq 100 is still up by twice as much as the S&P 500 this year.

Looking forward, we must ask how long tech's drop can remain benign. Will the "rotation" (into this year's lagging groups) continue if the tech group falls further?

Our view is that this is unlikely.

First of all, any significant damage to the tech stocks will have an effect on overall investor confidence. These high-flying, high-growth stories have been seen as somewhat "bulletproof," and if they get shot full of holes, investors might start questioning more and more of their holdings.

On a more structural level, we also believe that the issue of leverage will have an impact. The level of margin debt has continued to new highs this year, and it's a safe bet that a lot of this leveraged money has gone into these high-flying tech names. As investors sell those shares, they will have to pay back those loans (or meet margin calls if things get ugly), so there won't be as much money available to "rotate" into other groups.

Leverage works both ways. Even though most investors are reluctant to admit that leverage has played a key role in helping their investments move higher (they always think it had more to do with them being smart), it can (and does) play a rather significant role on the way up — and on the way down.

We have the Fed's next meeting beginning on Tuesday, and the announcement on Wednesday. We have said many, many times in recent years that the Federal Reserve has become very "market dependent" in their rate decisions, but we seriously doubt that the market will fall enough for the Fed to change their minds about a rate hike this time around.

However, if this mild pullback in tech stocks becomes a full-blown correction, it could and should have an impact on how many more times the Fed will raise rates this year.

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