Update: FANG Stocks are getting hammered today.
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The fascination with the influence of a handful of giant tech stocks on the overall markets continued overnight, when one day after Bank of America found that the tech sector is now the "most overweight it has ever been", surpassing even the record clustering into tech during the dot com bubble, Goldman issued a report looking at the outsized influence of the five tech stocks in question which it dubs FAAMG – Facebook, Amazon, Apple, Microsoft and Alphabet, which have collectively added a total of $600 bn of market cap this year, "or the equivalent GDP of Hong Kong and South Africa combined."
This is also the group of names which we reported last month is what virtually every brand name hedge fund purchased in the first quarter based on 13F filings, as active managers abandoned "value" names and factors and rushed into "momentum" and "growth."
Looking at this cluster of tech names, Goldman's Robert Bouroujerdi writes that "while FANG has dominated investor focus, the nature of the acronym has expanded more broadly to encompass mega-cap tech. Indeed, the bigger story in our view is FAAMG – Facebook, Amazon, Apple, Microsoft and Alphabet – a group of five stocks which have been the key drivers of both the SPX & NDX returns year-to date. This outperformance, driven by secular growth and the death of the reflation narrative, has created positioning extremes, factor crowding and difficult-to-decipher risk narratives (e.g. FAAMG’s realized volatility is now below that of Staples and Utilities)."
The run in large-cap tech stocks (with the top 5 accounting for a stunning 55% of the Nasdaq's YTD gains) has evoked memories (nightmares?) for some investors of the last euphoric NASDAQ run.
Below Goldman lays out some of the unintended portfolio consequences that have resulted from everyone rushing into this biggest every hedge (and mutual) fund hotel ever:
- Ownership. Per our US Portfolio Strategy team, all five stocks are currently in the top 10 of the Hedge Fund VIP basket with Facebook, Amazon and Alphabet holding the top 3 spots. Mutual funds across Core, Growth and Value are also overweight all but Apple and the five names combined are 11.8% of holdings vs. a blended benchmark of 11.2%.
- FAAMG through the Factor Lens: A strong relationship with our Investment Profile (IP) Growth and Momentum factors should come as no surprise, but FAAMG also increasingly trades like Low Vol. Indeed, FAAMG’s correlation over the last 5 years to Growth, Volatility and Momentum sits in the 92%, 90% and 96th%ile. Further Momentum as a factor, in isolation, has built a valuation bubble underneath it not seen since ‘Factormageddon’ of last year.
- Realized Volatility (6m) for FAAMG has fallen over the last year and is currently not only below that of the average stock in the S&P 500 but is also below the average Consumer Staples & Utilities stock ignoring any potential cyclical, regulatory (e.g. antitrust, online activity) or tech disruption risk.
- Like many other asset classes, FAAMG is cueing off 10-year bond yields, but not in the direction you might expect. Post the election, correlation turned negative, which is more analogous to a bond proxy/yield sector such as Staples or Utilities.
- Within the NDX, Biotech is the largest non-Tech sector (now 8%). While the space tends to be positively correlated to Tech and secular growth, it has recently turned negative.
And here Goldman issues a warning for the factor investors: "driven by the rise of mega-tech, Momentum, as a factor, has built a valuation air pocket underneath it creating cause for pause."
In Goldman's view, the sector has gotten ridiculously crowded, as a result of the soaring reliance on factor investing. GOldman notes that downside risk increases when factor valuations are stretched vs. history. To that end, the current P/E of the long/short Momentum factor is 1.8 std. deviations above its 3-year average, which is a level last seen in early 2016 just prior to “Factormageddon” – a period in late Q1:16 when the momentum factor fell sharply amidst a spike in factor volatility.
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And finally, for those worried this is Dot-Com boom bust all over again, Goldman offers a head-to-head comparison of the five largest Tech stocks at the peak to the Big-5 today on a number of different metrics including size, valuation, profitability and free cash flow.
- Size – a draw: While the current FAAMG stocks are almost 30% bigger than the Bubble stocks in market cap terms, they aren’t as large a portion of the index (~16% of the S&P at the peak, vs. FAAMG at 13% today).
- Valuation – Advantage: FAAMG: During the Bubble, the five largest Tech stocks traded at almost 60x FY2 P/E with the “cheapest” stock (LU) trading at 36x. Currently, FAAMG trades at around 23 X FY2, with only one stock (AMZN) trading over 30x.
- Cash balances – Advantage: FAAMG: All the FAAMG stocks have significantly more cash than the Tech stocks did back in the Bubble by an order of almost 8x. The difference is also significant as a percentage of enterprise value (13% for FAAMG vs. 2% for Tech in the Bubble).
- Free Cash Flow – Advantage: FAAMG: FCF generation for FAAMG stocks is still relatively robust, though has plateaued recently. Despite this slowdown, FCF margins still stack up modestly better than Tech. However, the real difference emerges in favor of FAAMG on a yield basis (reflecting the stretched valuation levels), where the current aggregate is 400 bp higher.
- Profitability– Advantage: Tech Bubble: Asset productivity (Gross Profits / Total Assets) was significantly higher for the Tech Bubble stocks than FAAMG today, likely an indication that these businesses have gotten more capital intensive over time. Similarly, ROIC was higher though we note this could be skewed by accelerated depreciation practices today. These strong profitability metrics suggest the Tech Bubble was more a valuation problem than an issue with fundamentals.
So the bottom line is - despite valuation air-pockets, there's plenty of room to run on this epic bubble as long as G3 Central Banks keep buying...