The First Crack Appears In The Second Tech Bubble

By now everyone knows it: what is going on with a handful of tech stocks is remarkably similar to the irrationally exuberant events from the first tech bubble at the turn of the century.

Four weeks ago, Goldman pointed out that in 2017, just 10 companies are responsible for half of the entire S&P's rally YTD with the top five, AAPL, FB, AMZN, GOOGL, and MSFT – have accounted for nearly 40% of returns.

Shortly thereafter, when looking at the latest set of 13F filings we found that virtually every prominent hedge fund has piled into the most prominent tech names: As Bloomberg noted, with an average gain of 26% , "it’s hard to overstate the influence of just six stocks on the U.S. stock market in the first quarter: Facebook Inc., Apple Inc., Inc., Microsoft Corp., Alphabet Inc. and Netflix Inc."

This was shown just days later by Bank of America which showed that annualized tech inflows are now the strongest this century, running at an unprecedented 25% of AUM, which BofA dubbed a "sign of renewed exuberance."

These dramatic inflows into tech prompted the same Bank of America to wonder, rhetorically, whether the "tech bubble was happening again."

Fast forward to today, when in a separate report, Bank of America's Savita Subramanian found that the active managers tracked by the bank now own the highest percentage of technology stocks on record compared to their benchmark.

As BofA writes, FANG stocks (FB, AMZN, NFLX, GOOG/GOOGL) have returned nearly 30% YTD vs. 8% for the S&P 500 (a contribution of about 1ppt or 14% of the S&P 500's returns this year). Fund managers are now 32% overweight Information Technology + Internet & Catalog Retail (a Discretionary industry). And this is driven by a remarkable 71% overweight in FANG stocks.

Expanding the FANG universe and screening for tech stocks with sales growth of 20% or more, an expected long-term growth rate of 15% or more, and a market cap of over $65BN yields two more names: ADBE (+38% YTD) and AVGO (+36%), a group of stocks which the bank refers to as FAAANG, and says that "active managers' disproportionate overweight to FAAANG relative to Tech sector and Internet and Catalog Retail is even more marked than the FANG stocks." As shown in the chart above, active managers are a record 79% overweight the FAAANG stocks.

And, as we stated at the beginning of this post, this unprecedented scramble into tech names has not gone unnoticed. Bloomberg cites, Matt Maley, a strategist at Miller Tabak who wrote in a note to clients that "the tech stocks obviously continue to be the key group to keep an eye on. They are over-bought on a near-term and intermediate-term (and even long-term) basis, but that has been true every day for the past few weeks.” 

Meanwhile, the move toward growth and momentum stocks "further cements active managers’ distrust in the value trade", which can be seen clearly on the Goldman chart below.

As Bloomberg notes, "Value had a record stretch last year that was predicated on economic expansion, the anticipation of pro-growth policies and a predicted pick up in inflation. But as those shares -- and expectations -- stalled, active managers are finding it hard to fight the crowd."

As for the crowd, it also knows it: investors surveyed by Bank of America in May said that betting on the tech-heavy Nasdaq index was the most crowded trade in markets. And yet, everyone is doing it.

And while tech may be the biggest hedge fund hotel in history, so far the shift to growth and momentum from value appears to be behind an improving hit rate for active funds, and as BofA also points out, the percent of funds beating their benchmark this year stands at its highest since February 2015. Of course, the reason is simple: everyone keeps piling into the same trade, which - as Paul Singer noted - works until it doesn't.

For now it's working: the tech-powered rally has propelled the sector to a P/E ratio of 24.4x, 41% above the 10-year average.  According to FT calculations, excluding technology and telecoms shares, the S&P 500 is up 5.3% this year, while the tech sub-index has climbed almost 20%.

"Annualised, that would make 2017 the best year for the industry since the post-crisis 2009 rebound and comes close to the heady days in 1998-99 that preceded the dotcom bubble bursting."

Which is an appropriate comparison, because the first crack in this particular tech bubble has now appeared. 

As Google and Amazon stretch to nearly $1,000 a share, not everyone is comfortable with the valuations, Bloomberg observed on Tuesday.

As the chart below shows, investors pulled more than $716 million from the most popular technology exchange-traded fund last week, the $17.4 billion Technology Select Sector SPDR Fund, or XLK, its largest weekly outflow in over a year.

As Miller Tabak's Matt Maley said in his note, "everybody remembers 2000, so they might be getting a little nervous with this development. I just wonder how many people have said to themselves, ‘If AMZN gets to $1,000, I’m going to take at least some profits.’” And another question: now that the first sellers have emerged, will the herd follow...