Deutsche Bank: The "fifth wave of tech stock rally" in US stocks since late July has peaked, prepare for a "V-shaped reversal"

The rally in US tech stocks that started on July 29 has outperformed the broader market by 18.1 percentage points over 52 trading days. However, according to Deutsche Bank, this rally has run its course.

According to Wind Trader, on October 9, the bank’s multi-asset strategy team, including analyst Parag Thatte, released a report downgrading its rating on US tech and mega-cap growth stocks (MCG & Tech) from “Overweight” to “Neutral.” The analysts wrote:

The rotation in tech stocks has gone a long way; the recent risk-reward is no longer attractive.

A Downward V-Shaped Reversal Approaching?

Deutsche Bank tracked five rotation cycles in US tech stocks over the past two years.

Data shows that the median gain of the previous four rebounds was about 29.5 percentage points (relative to the broad market), while the current rally had outperformed by 18.1 percentage points as of October 8.

Analysts pointed out that the relative performance of tech stocks now is close to the upper band of the long-term trend channel—precisely where several previous reversals began.

Specifically, tech stocks currently still have about four percentage points of upside relative to the broad market before hitting the channel's top, but once it peaks and retraces, historical trends suggest the downside can reach 16 percentage points. The report wrote:

Past rotations have all shown downward V-shaped reversals.

Position Asymmetry: Tech Overweight, Other Sectors Underweight

Positioning data also supports this assessment.

As of October 8, the position in tech and mega-cap growth stocks was at the 58th percentile—down from recent highs but still clearly overweight.

Meanwhile, other sectors are facing a very different situation:

• Financials’ position dropped to the 17th percentile, indicating significant underweight

• Industrials are at the 38th percentile

• Materials are at the 20th percentile

• Consumer staples are at the 19th percentile

Analysts noted that active investors’ overall positioning is at the 32nd percentile, which is moderately underweight, while systematic strategies’ position remains at the 85th percentile, though it has recently declined.

Strong Earnings May Not Boost Stock Prices, Market Focus Has Shifted

Analysts expect tech stocks’ earnings growth rate in Q3 to be about 55%, continuing a strong momentum.

However, this may no longer be enough to push stock prices higher.

The market’s worries are now focused on future earnings power, which is hard to resolve in the short term.

In contrast, the bar for non-tech sectors is extremely low—the market generally expects little to no growth. But Deutsche Bank forecasts Q3 earnings growth for non-tech sectors at about 21% year-over-year, nearly on par with 23% in Q2. The median S&P 500 company’s earnings growth is still expected to remain in the low double digits.

“The bar is very low for other sectors, with the market widely expecting little to no growth—but in reality, growth remains quite strong.” Analysts believe these expectation gaps provide the foundation for rotations.

Rotation Direction: Funds Flowing to Other Sectors, Market Breadth May Improve

Analysts believe the high concentration of tech stocks has always led to worries about insufficient market breadth, and the past two months are no exception.

Once capital rotates from tech stocks to other sectors and small-cap stocks, this concern is likely to ease.

Historically, in phases when tech stocks rotate out, the median gain for non-tech sectors is about 3 percentage points, while tech stocks on average fall about 14.8 percentage points.

Cross-regionally, the report points out that tech stock exposure is a key variable in determining regional market performance. The European market, where tech only accounts for 9%, would have an advantage in such rotations compared to the US market, where tech accounts for 40%.

Sharp Fall Risk: Past Experience Suggests Caution Over External Shocks

A key question is whether a tech stock rotation will be accompanied by a broader market downturn. Analysts wrote:

Recent history indicates the answer is yes—but it is important to note that these rotations usually coincide with major external shocks, such as "Liberation Day" trade tariffs and the outbreak of the Iran War, events that drag down all stocks.

In other words, absent a major external shock, this rotation is more likely to be a structural sector rebalancing, rather than a systematic market decline.

Long-Term Trend Unchanged: Tech Stocks’ Outperformance Thesis Remains Intact

Notably, Deutsche Bank’s downgrade only applies to short-term tactical positioning.

Analysts said the long-term trend of tech stocks outperforming the broader market remains intact. Over the past decade, tech stocks have outperformed the remaining S&P 500 constituents by about 14 percentage points annually, driven by persistently stronger earnings growth.

We believe this dynamic will not change.

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