This rally in US tech stocks that began on July 29 has outperformed the broader market by 18.1 percentage points over 52 trading sessions. But in Deutsche Bank's view, this run is already over.
According to information from a trading desk source, on October 9 the bank's multi-asset strategy team, led by analysts including Parag Thatte, published a report downgrading US tech and large-cap growth stocks (MCG & Tech) from "overweight" to "neutral." The analysts wrote: The rotation in tech stocks has already gone very far, and the risk-reward has ceased to be attractive in the near term.
Is an inverted-V reversal coming?
Deutsche Bank tracked the five rotation cycles in US tech stocks over the past two years.
The data shows that the median gain of the previous four rallies was about 29.5 percentage points (relative to the broader market), while this round, through October 8, had already outperformed by a cumulative 18.1 percentage points.
The analysts noted that the relative performance of tech stocks has now approached the upper bound of its long-term trend channel — precisely the starting point of several previous reversals.
Specifically, tech stocks still have about 4 percentage points of upside relative to the broader market before touching the top of the channel, but once they peak and turn lower, historical patterns show the relative drawdown can reach 16 percentage points. The report stated: Past rotations all exhibited inverted-V reversals.
Asymmetric positioning: tech overweight, most other sectors underweight
Positioning data also supports this judgment.
As of October 8, positioning in tech and large-cap growth stocks stood at the 58th percentile; although it has pulled back from recent highs, it remains clearly overweight.
At the same time, other sectors are in a very different situation:
Financial sector positioning has fallen to the 17th percentile, a significant underweight.
Industrial cyclicals sit at the 38th percentile.
Materials are at the 20th percentile.
Consumer staples are at the 19th percentile.
The analysts noted that overall positioning among active investors is at the 32nd percentile, already a modest underweight; while systematic strategy positioning is at the 85th percentile, it has also retreated recently.
Strong earnings may struggle to lift share prices as market focus has shifted
The analysts expect third-quarter earnings growth for US tech stocks of about 55%, extending the prior strong momentum.
But that may no longer be enough to drive share prices further higher.
Market concerns are now concentrated on future profitability, a problem that is difficult to dispel in the short term.
By contrast, the bar of expectations for non-tech sectors is extremely low — the market broadly believes these sectors have almost no growth. But Deutsche Bank forecasts third-quarter earnings growth for non-tech sectors of about 21% year on year, little different from 23% in the second quarter, and median S&P 500 company earnings growth is expected to remain at a relatively high level in the mid-to-high teens.
"The bar is very low for other sectors, and the market broadly believes there is almost no growth there — but in reality growth remains quite strong." The analysts believe this expectation gap forms the basis for rotation.
Direction of rotation: capital flows to other sectors, market breadth expected to improve
The analysts believe the high concentration in tech stocks has historically raised concerns about insufficient breadth, and the past two months have been no exception.
Once capital rotates from tech stocks into other sectors and small caps, this concern is expected to ease.
Looking at historical data, during phases when tech stocks rotate out, the median gain in non-tech sectors is about 3 percentage points, while tech stocks on average fall about 14.8 percentage points.
Across regions, the report noted that tech exposure is a key variable determining regional market performance. Europe, where tech accounts for only 9%, is better positioned in a rotation than the US market, where tech accounts for 40%.
Crash risk: historical experience suggests vigilance against external shocks
Whether a rotation out of tech stocks would be accompanied by a broader market decline is a key question. The analysts wrote: Recent history suggests the answer is yes — but note that these rotations often coincided with major external shocks, such as the "Liberation Day" tariff shock and the outbreak of the Iran war, events that dragged all stocks down together.
In other words, absent a major external shock, this rotation is more likely to be a structural sector rebalancing rather than a systemic market decline.
Long-term trend unchanged: the logic for tech stocks' long-term outperformance still holds
It is worth noting that Deutsche Bank's downgrade this time is only at the short-term tactical level.
The analysts said the long-term trend of tech stocks outperforming the broader market remains intact. Over the past decade, tech stocks have outperformed the rest of the S&P 500 by about 14 percentage points annualized, supported by persistently stronger earnings growth.
We do not believe this dynamic will change.
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