Tech is flashing a warning sign last seen in 2020. Strategist Larry McDonald sees a massive rotation coming.
The market’s leadership is narrowing again, with megacap technology carrying a disproportionate share of returns while the rest of the field lags. To seasoned observers, that combination—soaring index levels atop weakening participation—looks eerily familiar. It resembles the setup that preceded the 2020–2021 handoff from hyper-growth tech to cyclicals and value, a move that punished crowded trades and rewarded under-owned assets.
Larry McDonald, founder of The Bear Traps Report and a longtime student of cross-asset flows, argues that another dramatic rotation is taking shape. In his view, the same fault lines that cracked four years ago—rising real yields, liquidity drain, and heavy crowding in a handful of tech winners—are visible again. If he’s right, investors clinging to a narrow slice of the market could be blindsided by violent rebalancing.
What the warning sign looks like
The “tell” isn’t a single indicator; it’s a cluster of conditions that tend to emerge late in a momentum cycle:
– Breadth divergence: Indexes driven by a few giants while fewer constituents make new highs or even trade above key moving averages. In 2020, the Nasdaq 100 sold off hard after weeks of record highs set against deteriorating participation.
– Concentration risk: Market-cap-weighted benchmarks sprint ahead of their equal-weight cousins. The cap-weighted S&P 500 can levitate on a handful of megacaps even as the median stock stalls.
– Complacent options markets in leaders: Single-stock options activity piles into the same tech names, suppressing perceived risk in those names while masking fragility if positioning unwinds.
– Crowding and factor fatigue: Growth and momentum factors become richly valued relative to value and cyclicals, leaving little margin for disappointment.
These aren’t just technical curiosities. They’re signals about how capital is allocated. When most of the world owns the same winners for the same reasons, the marginal buyer disappears quickly—and small shocks can create outsized moves.
Why the setup rhymes with 2020
The 2020 rotation was catalyzed by a handful of forces: a surge in real yields off pandemic lows, vaccine-driven reopening optimism that turbocharged cyclicals, and an unwind of speculative options positioning in mega-cap tech. Today’s macro backdrop is different in detail but similar in essence:
– Real yields and the cost of capital: Higher or rising real rates compress duration assets—especially long-duration growth equities—more than short-duration value and cash-flow-rich cyclicals.
– Liquidity and deficits: Ongoing Treasury issuance, quantitative tightening, and shifting global reserve demand can drain liquidity from the most richly priced assets first.
– Earnings mix: After multiple years of tech-led profit expansion, incremental surprises may skew to areas tied to capex, industrial demand, and commodity cycles.
– Positioning asymmetry: Hedge funds and retail flows have repeatedly crowded into the same AI-adjacent names. Crowding makes good companies bad stocks at the wrong price.
McDonald’s rotation roadmap
McDonald has often argued that “old economy” winners emerge when the cost of capital rises and global nominal growth proves stickier than consensus. The rotation he envisions tends to share a few traits:
– From cap-weighted growth to equal-weighted, dividend-paying value
– From software/platform dominance to tangible assets and balance-sheet cash flows
– From U.S. megacaps to cyclically geared sectors and select non-U.S. markets
Areas he has historically highlighted when this pattern appears:
– Energy and materials: Beneficiaries of capital scarcity, disciplined supply, and resilient demand. Producers with free-cash-flow yields and conservative balance sheets can rerate even without higher spot prices.
– Financials: A steeper yield curve and credit normalization can lift net interest margins and earnings power for high-quality banks and insurers.
– Industrials and logistics: If capex and supply-chain “re-shoring” continue, backlogs and pricing power support margins.
– Select emerging markets and commodities: Latin America and resource-heavy markets often outperform when the dollar stabilizes and global nominal growth holds up.
– Precious metals and miners: If policy makers lean dovish into sticky inflation or fiscal strain, gold and quality miners can hedge both financial repression and equity volatility.
How rotations typically unfold
Rotations rarely ring a bell at the top. They appear chaotic, then obvious in hindsight. A plausible sequence:
1) Leadership stumbles on an earnings miss, guidance tweak, or a rates jump; breadth fails to confirm rebounds.
2) Dispersion spikes as former winners gap lower while neglected sectors grind higher.
3) Passive flows and risk-parity frameworks rebalance, accelerating the move.
4) Capital follows performance into cyclicals and value, reinforcing the leadership change.
Signposts to watch
– Breadth and concentration: Equal-weight vs. cap-weight ratios; percentage of index members above 50- and 200-day moving averages; new-high/new-low lists.
– Real yields and the curve: Sustained rises in 5- to 10-year real rates and any credible steepening of the yield curve.
– Credit spreads by sector: Tightening in energy/industrial credits alongside widening in long-duration tech credits would confirm rotation stress.
– Positioning and options: Extreme net longs in tech futures, persistent call buying, or skew dislocations can foreshadow sharp reversals.
– Earnings revisions: Upward estimate revisions shifting toward cyclicals and away from megacap growth.
Risks to the call
No rotation thesis is bulletproof. Counterarguments include:
– AI productivity and revenue surprises continue to outpace expectations, preserving tech’s earnings lead.
– A growth scare or rapid policy easing pushes yields lower, re-expanding duration valuations.
– Regulatory or geopolitical shocks hit cyclicals/financials harder than tech.
– Dollar strength pressures commodities and emerging markets, muting value’s relative bid.
How investors can respond
– Rebalance concentration: Trim outsized megacap exposure; add equal-weight or value tilts to reduce leadership risk.
– Build a barbell: Pair quality cyclicals (energy, industrials, financials) with durable growth at reasonable prices.
– Prefer cash flow and balance-sheet strength: Within every sector, emphasize free cash flow, conservative leverage, and pricing power.
– Hedge with purpose: Consider protective puts on concentrated tech exposure or relative-value hedges (e.g., long value vs. short growth baskets) sized to risk tolerance.
– Stagger entries: Rotations are volatile; scale positions rather than betting on a single turn date.
The bottom line
Markets cycle between stories and cash flows, between dreams and discipline. When leadership narrows and breadth deteriorates, the dream basket gets fragile. Larry McDonald’s warning is less a prophecy than a probability: if the cost of capital stays firm and liquidity is selective, the crowded trade in big tech can unwind abruptly, handing the baton to cash-generating cyclicals and value. Whether the next leg higher in equities is broad or brittle will depend on how that baton pass plays out.
This article is for informational purposes only and does not constitute investment advice. Consider your objectives, risk tolerance, and constraints before making investment decisions.
