Today's surge in AAPL stock, when news of more purchases by Warren Buffett in the first quarter unleashed a buying frenzy, sending the stock to a new all time high, had a secondary effect of accelerating the entire FAANG sector (Facebook, Apple, Amazon, Netflix and Google), which now makes up a bigger piece of the tech pie than ever before.
As the chart below show, FAANGs now accounts for over 27% of the Nasdaq Composite, a new all time high, doubling in the past 5 years.
It also triggered a warning from none other than Goldman Sachs which looked at a similar ratio, that of the Info Tech sector as a $ of the S&P, and conclude that "Large exposure = large risk"
First, some background on the stunning impact of tech stocks on the overall market:
Over the last five years, fast sales growth and high profit margins have driven the Technology sector to contribute 73% of S&P 500 margin expansion and one-third of EPS growth. The strong fundamentals have led to remarkable outperformance: Since the start of 2017 the Tech sector has contributed 43% of the total S&P 500 return, with the “FANG” stocks alone accounting for 12% of the market return.
That's the good news. Now the not so good.
First: unprecedented concentration: the Tech sector’s widespread popularity raises the risk facing portfolio managers. At the start of 2018 Tech stocks accounted for 26% of large-cap mutual fund portfolios, equating to a 235bp overweight relative to benchmarks, the largest among sectors. Hedge fund filings show a similar preference among levered investors, with 24% net exposure to Technology. Passive investors are also exposed to the risk of a downturn given the Tech sector’s large market weight, at 25% of S&P 500 market cap.
Second: the historical record: During the last 50 years, only the Energy sector in the early 1980s (26% weight), Tech in the late 1990s (35%), and the Financials sector in the mid-2000s (22%) have similarly exceeded 20% of S&P 500 index weight.
It is what happened next that is of major concern, because as Goldman recounts,forebodingly, "those three episodes each culminated in an absolute price decline in excess of 50% for the high-flying sector and underperformance relative to the S&P 500 of roughly 30%."
In other words, the higher they get, the harder they fall.
Worse, as Goldman's Ben Snider warns, "arithmetically, the Tech sector’s large weight could easily drag down the broad market if investors cut exposures without finding an appealing place to reallocate."
Even worse, there is no place to run, as 2018 has witnessed the largest and fastest rise in stock correlations on record outside of 1987, with Tech sector correlations in particular rising far above their historical averages. In other words, "the current market environment makes it difficult for investors to embrace the parts of the Tech sector not facing fundamental risk from potential regulation, despite their appeal"
Snider's parting words of caution: with the Tech sector facing increased regulatory scrutiny, "investors are asking how much risk Tech poses to their portfolios—and whether another sector can pick up the slack, should Tech leadership crumble."
Or maybe they are just imitating Warren Buffett: after all, the last time the Berkshire billionaire got in trouble with his bank holdings in 2008, the government bailed him out. Surely, if there is one sector that is the "new banks" in 2018, that would be the FAANGs, because if it goes down, so does Buffett, so does almost every hedge fund, and ultimately, so does the market.