One expert thinks tech stocks are doomed to plunge 14% into another correction. Here’s how he says traders can protect themselves.

Reuters / Aly Song

• The tech-heavy Nasdaq Composite index has outperformed since the stock market’s late-December sell-off, and one expert says that makes the group especially vulnerable to another downturn.
• Julian Emanuel — the chief equity and derivatives strategist at BTIG — explains why he’s worried about the Nasdaq, and outlines how investors can protect themselves against sharp losses.

No area of the stock landscape has enjoyed a bigger recovery following December’s bear-market scare than the tech-heavy Nasdaq Composite index.

While the benchmark S&P 500 has climbed 20% since Dec. 24, the Nasdaq has outdone it by surging more than 24%. Considering tech has been one of the top contributors to the 10-year bull market, the Nasdaq’s recovery suggests equities have reverted back to their long-standing status quo.

Not so fast says Julian Emanuel, the chief equity and derivatives strategist at BTIG. He thinks the Nasdaq — and, by extension, the tech sector — has gotten too stretched for its own good.

Emanuel points to the chart below, which shows a technical analysis tool called the relative strength indicator. An RSI reading exceeding 70 means the market is overbought and a downturn may be imminent and, as you can see, the Nasdaq has been flirting with that level for some time.

BTIG

Going beyond simply technical factors, Emanuel is also troubled by what he sees in the near-term macro landscape. For one, a manufacturing slowdown has combined with Brexit to drag German yields into negative territory.

Since the Treasury yield curve is so closely intertwined with its German counterpart, this doesn’t bode well for the US economy as recession worries flare. And as those worries mount, that negative sentiment will be a drag on equities. We experienced these dynamics first-hand on March 22, when US stocks tumbled.

Read more: Forget the yield curve. Morgan Stanley says investors should be focused on a superior recession signal — one that’s threatening to flash by year-end.

By Emanuel’s logic, the stocks that have risen the most since recent lows also have the furthest to fall. Which brings him to his bearish outlook for the Nasdaq, which he says could drop as far as 6,600. Considering the index closed at 7,691.52 on Tuesday, that would be a 14% decline — enough to qualify for a dreaded market correction.

"Given overbought readings, it is unlikely that the US equity market can remain independent of Europe," Emanuel said in a recent client note.

So what are investors to do? Emanuel advises them to identify the Nasdaq stocks that have gotten the most egregiously stretched, then put some downside hedges in place. He calls this especially vulnerable group the "Falling Angels," and it’s listed in full below.

Before we get to that, however, Emanuel has two single-stock trades he’s recommending in particular:

• Intuitive Surgical (ISRG), up 31% since Dec. 24 — Buy May $545 puts
• Workday (WDAY), up TK% since Dec. 24 — Buy May $185 puts

BTIG

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Source: Business Insider – jciolli@businessinsider.com (Joe Ciolli)