Not only do they dominate our daily lives, but as their stocks continue to soar, these technology giants may be dictating our financial futures as well.
In just three years, their share prices have risen far beyond the major market indexes — Amazon leads the way, up 206 per cent; Apple trails the pack with a 67 per cent return — as investors of virtually every stripe have piled into these companies.
But this gold-rush mentality, reminiscent of investor frenzies for Nifty 50 stocks in the late 1970s and the dot-com boom and bust at the end of the last century, is now giving investors pause. Not because they think these companies will crack, as many did in previous market corrections, but because in the parlance of the industry, the trade has become very crowded.
“There is valuation anxiety out there, that is for sure,” said Ed Yardeni, an independent investment strategist who often highlights the influence of these stocks in his research notes. “No one is feeling totally comfortable holding stocks that are this expensive.”
Despite some nervousness about a potential bubble building, stock indexes remain near recent record highs (without adjustment for inflation). Last week, stocks were slightly higher in cautious trading on the eve of several potentially market-moving events, including the British election and testimony from James B. Comey, the former FBI director.
Other markets have been robust of late, including gold, a traditional safe haven, and the virtual currency Bitcoin. But oil prices and the US dollar have weakened, with the Bloomberg dollar spot index at its lowest levels since the November 8 US election.
During the late stage of any bull market, investing in highflying momentum stocks requires investors to balance conflicting sentiments of greed and fear. Everyone wants to keep making money, but everyone also lives in fear of the party suddenly coming to an end.
According to FactSet, a data provider, since 2012, mutual fund, pension fund and hedge fund holdings in these five stocks have more than doubled to $1.4 trillion from $558 billion — a consequence of investors buying up stocks that are rapidly increasing in value.
As is its wont, Wall Street has given voice to this unease with a nickname: FAANG, an acronym for the five stocks that evokes a gruesome end more than it does the exuberance of the moment.
The push into these stocks has been driven by retail investors via traditional mutual funds, exchange traded funds and owning the stocks directly.
Through these channels, retail investors now own from 60 to 70 per cent of these stocks — an exposure of very large amounts of money to a small selection of stocks that investment experts say is unprecedented.
It is also dangerous, as a prolonged bout of selling in such a small number of stocks could spur a wider sell-off in the market. “In terms of magnitude, we have not seen this,” said Jim Paulsen, an independent stock market strategist.
In Paulsen’s view, a long period of subpar economic growth since 2009 has given the FAANG stocks their special aura. Most companies have struggled to show consistent earnings and sales growth over this period.
So, when Facebook’s net earnings leap to $10 billion from $1.4 billion in four years or Amazon’s sales jump to $135 billion from $74 billion, investors take notice.
“You have this small cadre of companies that are showing extraordinary growth in a very sluggish economy,” Paulsen said. “So yes — you can see how valuations would get extended.”
Stock market historians say that it would be unfair to compare today’s technology companies to the more speculative names that characterised the dot-com boom and bust in 2000. Progress can easily be measured via earnings and the cash-generating abilities these companies have, as opposed to counting eyeballs on the web, which was the norm during that earlier era.
Still, the question remains: How much more can the stock market valuations of these companies grow relative to the earnings they are producing?
For example, the current stock market size of the FAANG companies is $2.4 trillion, or about 13 per cent of the size of the US economy. By comparison, their combined earnings were just $77 billion last year — with more than half that amount coming from Apple, the world’s richest company.
Of course, in many cases investors are calculating that in the long term, earnings growth will catch up with sales expansion as well as heavy investment spending aimed at putting competitors out of business.
Amazon, whose $2.3 billion in earnings last year supports a market capitalisation of $483 billion, is the most profound example in this regard. Still, it is not today’s earnings you are betting on, but tomorrow’s, the argument goes.
Surprisingly, some of the most passionate advocates for these companies are value investors. These investment professionals have won reputations for snapping up companies trading at deep discounts to the market, not chasing stocks that fly high above it.
Bill Nygren, a value investor for more than 30 years, oversees the $5.8 billion Oakmark Select Fund, and his No. 1 holding in the fund right now is Google’s parent, Alphabet.
Nygren contends that the company is trading at a bargain to the market as opposed to a premium if you take into consideration Google’s cash pile and the potential of YouTube to make a lot of money in the future.
“I have not heard anyone advance the argument that the Google search engine is not even an average business,” Nygren said. “Yet that is how the market is pricing it.”
Another well known value manager who is betting big on FAANG stocks is Chris Davis, the lead stock picker for the $11.8 billion New York Venture Fund, where Amazon is his top position.
While sceptics see just $2 billion in earnings, he and his analysts see a company that has generated more than $15 billion in cash and is now ready for a higher market rating because of the profitability of Amazon’s web services division.
“Amazon is more fully valued than when we bought it,” Davis said. “But we have never seen a company with such competitive advantages.”
As these stock prices continue to surge higher, analysts agree that investors have little choice but to stick to their guns.
That is because the FAANG stocks have become such large components of the major stock market measures. For a manager not to match the share of an Apple or an Amazon in a benchmark would result in an actively managed fund trailing its index and its peers.
And as investors pour billions of dollars into exchange traded funds — a record $314 billion in the last year alone — no active manager can afford to to lag the competition for too long these days.
So be it a mutual fund, hedge fund, sovereign wealth fund or family office, the strategy has been consistent — put aside your fears and stay invested.
“It’s like you are riding a missile that you know could explode at any moment beneath you,” said Julian Brigden of Macro Intelligence 2 Partners, an independent research company based in Vail, Colorado.
He has warned in his reports that some of these stocks have entered a stage of mania. “But you have no choice but to be sucked into the trade.”
— New York Times News Service
