A trader works on the floor of the New York Stock Exchange (NYSE) in New York, U.S. (Photographer: Michael Nagle/Bloomberg)

Morgan Stanley Warns of Momentum Trap for Rebounding Tech Stocks

(Bloomberg) -- Two violent selloffs in as many months have done little to shake investors’ love for popular stocks such as chipmakers. To Morgan Stanley, that’s a risk that may come back to haunt the market.

Technology shares bore the brunt of selling in February and led the market’s subsequent rebound. The pattern was on display again Monday -- though with Facebook Inc. as a notable exception -- as the industry jumped 2 percent, outpacing most others after suffering the biggest drop last week.

While persistent leadership has helped the broad market avoid deeper losses, it also highlights a lingering danger for stocks: the risk that after everyone piled into the same winners, they’ll all try to jump out at the same time. Tech and consumer discretionary companies now occupy top rankings within the momentum trade that are “grossly" out of proportion with their share of the market, according to a Morgan Stanley note on Monday.

Morgan Stanley Warns of Momentum Trap for Rebounding Tech Stocks

“We have started to tilt our sector preferences more defensively and in a way that hedges against the momentum unwind risks,” wrote Michael Wilson, Morgan Stanley’s chief U.S. equity strategist, and colleagues. “While too early to make the call just yet, we think that when the market starts to rotate more defensively, there is a risk of pain at the portfolio level as the drivers of long and short momentum over the last two years will likely unwind quickly.”

Such concentration in and of itself doesn’t cause trouble for stocks, but it’s often a pressure point when sentiment starts to shift, according to the bank. Morgan Stanley’s urging investors to allocate more money to utilities and energy companies, shares that have lagged behind the market over the past 12 months.

Facebook Sinks

As most stocks rebounded Monday, the beloved FANGs included a big underperformer: Facebook sank another 2.4 percent to head toward its steepest monthly drop in more than five years. The Federal Trade Commission confirmed Monday that it has an open non-public probe into privacy practices at the company, which has lost more than $80 billion in market value in the past 10 days.

Still, thanks to quick snapbacks in darling stocks such as chipmakers, broad market momentum is intact, according to Morgan Stanley, which advised buying the S&P 500 Index at current levels. The gauge rose 1.3 percent as of 12:59 p.m. in New York, bouncing off its 200-day average again. The Philadelphia Semiconductor Index jumped 2 percent.

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