EquitiesSep 19 2018

How much bite do Faang stocks have?

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How much bite do Faang stocks have?

While Faang’s price-earnings multiples continue to surge forward in the face of obvious concern, there remains the fact that today’s tech bonanza remains wholly different from that of previous rallies, and that is down to cold, hard, earnings.

The Fanng business models are turning a profit, which puts them in direct contrast with the high-octane, low-earnings fuel that powered previous dot com rallies, and left many with more than just their fingers burned.

The downside this time around is the market has become fixated on these mega-cap, high-growth names being the proverbial ports in a storm, which has spiked their price-earnings multiples into speculative territory. 

The silver lining for anyone concerned about these companies’ long-term survival prospects is that it is clear the innovations being delivered by this group of five will continue to rapidly change the landscape in which we live, work and play, keeping them hyper relevant.

Key points

  • A tech rally could create fears for many investors.
  • When Apple has a bad day it drags the entire US market with it
  • Short-term investor behaviour is not always logical over the long term

Looking at headline risks around the globe it is little surprise investors are looking for safety. 

The current US President has threatened trade wars with China, the EU, Mexico, Canada, and Turkey – and withdrawal from the Korean-American trade deal that was reportedly only averted when his economic adviser “stole aletter off [his] desk”. 

The Italians are dangerously close to re-leveraging up an economy which has already maxed out its credit limits and the political infighting in Westminster is starting to erode what little respect we still have left on the global stage.

It is true to say the rally in Faang stocks has, so far, given global markets that much-needed boost at a time when political volatility could easily have caused markets to trade flat – and possibly even become negative – by the end of the year.

Eschewing the old investment adage of “buy low, sell high”, the market has continued to pile capital into these five large capitalised growth stocks. With the S&P 500 being calculated on a market cap basis, the more these companies’ value expands, the larger the proportion of the total market they occupy.

Effect on markets

The consequence? When Apple (the first company to reach $1trn (£0.77trn) in market capitalisation – recently joined by Amazon) has a bad day, its impact on the S&P 500 is such that it drags the entire US market down with it.

The collective market capitalisation of this exclusive club totals more than $3.25trn (£2.5trn): $1.15trn (£0.89trn) more than the entire value of the FTSE 100. To illustrate the impact of these five tech stocks, look at the MSCI World Index – which represents the 23 largest developed equity markets in the world. From January 2018 to July 2018 the index has risen 3.93 per cent.

Strip out the entire US equity portion from the MSCI World index and recalculate total performance, and you get a return figure of just 0.02 per cent. 

In short, without the US equity market contribution, the entire aggregated performance of the global stock market goes sideways.

So, the US market in 2018 has been the engine of performance for global markets – and looking under the hood of the US equity rally, we can see it is coming from a very select corner of the index.

The Faang stocks are currently being credited with over 80 per cent of the performance of the S&P 500 in 2018 – with Amazon’s share price at $1,876, up 50 per cent year-to-date, and Apple taking first past the post for a $1trn market cap company.

It is alarming that five companies within a global index of over 1,000 are driving 80 per cent of total market performance. Without Facebook, Amazon, Apple, Netflix and Google, our global equity market could, and most likely would, be in disarray.

Avoiding short-termism

What does this state of affairs mean for portfolio managers?

Simply put, managers who have spent years constructing diversified portfolios of global investment opportunities have found themselves at the mercy of this concentrated rally – because unless a portfolio is invested meaningfully into the US market and meaningfully into these five stocks (essentially an ETF) it is a good bet it will be struggling.

Good companies remain good companies irrespective of where the market is moving in the immediate future.

That said, just because a portfolio appears to be underperforming on a headline level does not mean what it is invested in are poor investments by any means.

If anything, it just illustrates how short-term investor behaviour does not always follow what is logical over the long-term.

Good companies remain good companies irrespective of where the market is moving in the immediate future.

On the flip side, with this level of performance concentration coming from five stocks it could be said we are going through a period of dysfunctional market behaviour in which investors ignore fundamentals in favour of simply chasing what is doing well – with little regard for how much they are paying for the privilege.

The saying: “the bigger they are the harder they fall” seems appropriate here.

The logic of markets is only ever temporarily suspended: the challenge, to paraphrase John Maynard Keynes, is to remain solvent for longer than they remain irrational. Before they correct themselves, however, they tend to become horribly overextended. 

A diverse, well-constructed global portfolio will, in the long run, rise to the top. 

There are, at most, six more years of President Trump – and it may take a while, but it is not unreasonable to expect through recession, impeachment or a return to normality that the market will de-Faang itself eventually. 

When it does, the traditional business of active portfolio management will step out of the passive shadow.

James Penny is a senior investment analyst at Tam Asset Management