Why overcrowding in tech stocks is still risky

Favoring large-cap technology stocks proved a winning strategy during the recent bout of volatility that sent the stock market into correction. But the risk of a crowded trade, one that could be ripe for reversal, in tech remains, according to analysts at RBC Capital Markets.

The S&P 500 SPX, +1.18% has recovered more than half of the losses from the correction earlier this month, when it dropped more than 10%. The benchmark index is up 3.4% since the start of the year, trading near 2,765. The much-beloved tech sector up nearly 9% year to date accounted for more than 60% of those S&P gains. Over the past 12 months, the S&P 500 is up 16.4%, while the tech sector gains are more than double that at 35%.

In fact, mega-tech names including Microsoft Corp MSFT, +1.45% Apple Inc. AAPL, +1.98% Netflix Inc. NFLX, +2.88% NVIDIA Corp NVDA, +0.26% and Alphabet Inc. GOOG, +1.51% contributed the lions share, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indexes.

Amazon.com AMZN, +1.46% technically a consumer discretionary company but often lumped in with tech, gained nearly 30% since the start of the year and contributed nearly a fifth of all the gains on the S&P 500, according to Silverblatt. So-called FAANG stocks, including Amazon, all hit intraday records (though they did not close at all-time highs) on Friday, an event that many technical analysts see as a bullish signal.

Read: Big Tech shake-up three stocks to buy and three to sell

Solid performance of the sector is one of the main reasons why these stocks continue to be popular with both the sell-side analysts and buy-side managers.

According to Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, sell-side analysts still overwhelmingly recommend buying tech stocks.

Net buy ratings (the percent of technology sector buy ratings less the percent of S&P 500 buy ratings) remain extremely high relative to history, though not quite back to tech bubble peaks, Calvasina wrote in a note to investors.

On the buy-side, mutual funds under the large-cap growth category continue to favor tech stocks with overweight allocations.

Calvasina points out that even though tech overweight allocations were below the 2016 highs coming into 2018, they are still above their long-term average.

Meanwhile, hedge funds, which are more likely to engage in tactical allocations, pared back their exposure to technology stocks during the last quarter of 2017 but were still overweight in early 2018, according to Calvasina.

Even though the latest correction spared this particular crowded trade, it does not mean that risk went away. Calvasina and her team are wary of such positioning risk and maintain a market weight recommendation on the tech sector.

Related Topics U.S. Stocks Markets NY Stock Exchange NASDAQ Quote References SPX +32.30 +1.18% MSFT +1.36 +1.45% AAPL +3.47 +1.98% NFLX +8.23 +2.88% NVDA +0.65 +0.26% GOOG +16.96 +1.51% AMZN +21.95 +1.46% Show all references MarketWatch Partner Center Most Popular Stocks could plunge another 25% if this happens, warns Goldman Sachs Head of worlds largest hedge fund says U.S. in a pre-bubble phase with a 70% chance of recession Big Tech shake-up three stocks to buy and three to sell Trump Today: President says he wouldve entered Florida high school without a gun