Equity investors have enjoyed a solid continuation of the bull market in the first half of 2017. It is notable, though, that a handful of large-cap stocks have clearly driven the market. Journalists and analysts have been playing around with different acronyms to select and describe the current tech high-flyers. For the first time in 2013, CNBC’s “Mad Money” host Jim Cramer propagated the term FANG, which stands for Facebook, Amazon, Netflix and Google (now Alphabet). Recently, reporters included another “A” to include Apple and an “M” to include Microsoft in the acronym, sometimes replacing the Netflix’ “N”, depending whether the story’s focus is “growth” or “dominance”.
Currently, an impressive headline is that FAAMG (Facebook, Amazon, Apple, Microsoft and Google) comprise 12% of the S&P 500 Index and have contributed 28% of the index’s year-to-date returns with a market-cap weighted combined return of 25%. If we look at the NASDAQ 100, FAAMG has accounted for more than 50% of the return in 2017. What is more, until recently, the trend has been remarkably solid with a very low volatility. However, on Friday June 9, the tech started to sell off without any fundamental reason. The following Monday morning, the NASDAQ showed a loss of 4.5% from the Friday high, driven by heavy losses of the FANG and FAAMG groups wiping out a market capitalization more than 200 billion in these six companies. Suddenly, the financial press started to draw analogies between today and the dotcom bubble. Obviously, this comparison is far-fetched.
The most important difference is valuation. In the first months of 2000, the S&P 500 Technology Index reached a 12-month forward Price/Earnings Ratio of 60, which was more than twice the valuation of the S&P 500. Today, the tech sector is trading at a multiple of around 19, just narrowly above the market’s valuation. It is true that the valuation has gone up in the last years and the valuation is not cheap anymore, but it is certainly not in bubble territory.
More importantly, today’s tech giants have much stronger fundamentals with solid growth prospects. They still sit on a $ 700 billion cash pile, but started to invest huge amount of cash in their infrastructures and new growth areas. Today, the FAAMG companies have leading positions in at
least one of the most promising investment trends, such as cloud computing, artificial intelligence & machine learning, virtual reality & augmented reality and big data. They all benefit from a secular shift to online spending. For example, Amazon Web Services (AWS) accounts for more than one third of the global cloud infrastructure market generating $ 12 billion a year from nothing five years ago. This segment is expected to grow more than 15% annually. Amazon’s scale and leading IT and logistics infrastructure is highly disruptive for traditional retailers, especially as it enters the traditional bricks-and-mortar retail segment (best illustrated by the announced Whole Foods acquisition). Facebook has increased its monthly active users from 1.4 to an impressive 1.9 billion and more than doubled its revenues in the last two years. The company is ramping up its investments in research & development including video content and augmented reality, which should help to main profit growth north of 20% for several years. Alphabet has consolidated its leadership in mobile search ads and strengthened its positioning in video (YouTube), the cloud and Google Play. There might be interesting start-ups in these high-growth areas, but the difference in scale and resources compared to the leaders has never been so vast.
So if valuations are reasonable and fundamentals strong, what has caused the mini sell-off? Most analysts are pointing to an increasing dependence of algorithmic trading. JPMorgan estimates that only 10% of US stock trading comes from traditional traders. The machines are taking over. Before the correction, the positioning in the FAAMG stocks was extreme. Fund managers were overweight and the machines were long, following the strong momentum of growth stocks. Also the untypical low volatile of these stocks attracted the machines. The trigger for the sell-off is not really clear. Many point to a cautious Goldman Sachs research report published on Friday, June 9 that might have caused some selling pressure. Once the short-term trend was broken and the volatility spoke up, the machines took over and continued liquidating positions. The good news is that the sell-off stopped after only two days and that the pressures from quantitative traders has probably played out. The bad news is that investors that want to benefit from the strong long-term prospects of these tech companies should get used to higher volatility again. But the tech leadership is most likely here to stay.
Por Fórmate a Fondo
Por Alicia Miguel