Investors are in love with tech stocks again—the Nasdaq Composite Index is up more than 19% from a late-December low. But the love affair could end badly, warns Morgan Stanley. “Tech has the potential to be a pain trade for consensus in 2019,” the firm warns in a recent report. To protect themselves, “Investors could benefit from looking at alternative hedges,” the report said, according to a detailed story in Bloomberg.

Tech’s Big Rally

(% Gain Nasdaq 100)

·           Since 12/24: +18.7%

·           Since 12/31 (YTD): +10.6%

Source: Yahoo! Finance, as of 4pm EST 13/02.

What it Means for Investors

Tech stocks have posed strong performance across the globe, with the MSCI World Information Technology Index up 11.7% year-to-date. But Morgan Stanley has held an underweight position in the sector, and the bank’s analysts are skeptical that tech stocks will continue to outperform, per Bloomberg.

Morgan Stanley attributes the recent rally to a more dovish Federal Reserve, but the firm says the tech sector still faces difficult hurdles ahead. “While the Fed’s dovish rhetoric last meeting is supportive of a rally in the near term, the year ahead is still challenging in terms of tough earnings comps, slowing growth and rising inflation,” wrote the analysts, according to the same story.

Despite the rising risk of a tech sell-off, Morgan Stanley says high volatility has made hedges on tech stocks unusually expensive right now. When risk rises, premiums for protection tend to rise in unison. With scant opportunities to take cover, investors may need to look for alternative hedges.

The trick is to find hedges that, while linked to the tech sector, are much less volatile and thus much cheaper alternatives. Morgan Stanley suggests purchasing call options that pay off from a rising U.S. dollar relative to the Korean won, which is trading at its least volatile levels in seven years. South Korea’s importance to the global technology supply chain means the won could take a hit if the tech sector falters. The firm also advises using put spreads on emerging markets, which are more exposed to tech than before, per Bloomberg.

Looking Ahead

Despite Morgan Stanley’s skepticism, other investors think tech stocks may have even more upside. Tech investor Paul Meeks said last week that the Nasdaq will end the year at least 10% higher with most of the gains taking place in the latter half of the year, according to an interview with CNBC.