News & Our Thinking

Argent in the News

Facebook’s Plunge Shows Risk of Narrow, FAANG-Led Market

03 August 2018

(St. Louis Post-Dispatch)

Aug. 4, 2018 (David Nicklaus)

As Facebook investors learned last week, the law of gravity still applies to at least some high-flying tech stocks.

The social media company’s single-day loss of $120 billion in value highlights the risks in a market that has been driven by just a handful of companies. Even after that flameout, the so-called FAANG stocks — Facebook, Apple, Amazon, Netflix and Alphabet, the parent of Google — account for two-thirds of the 5.8 percent gain the Standard & Poor’s 500 has piled up this year.

One of those stocks, Amazon, is responsible for a third of the index’s gain. Add in a handful of other technology and payments companies — Microsoft, Adobe, Mastercard, Visa and PayPal — and just nine stocks account for all of the S&P 500’s advance.

That means 491 other stocks — manufacturers, health care firms, banks and the rest — have been, on balance, flat this year. We use the S&P 500 as an approximation of the broad market, but its leadership has been extremely narrow.

Such markets can be volatile, as Facebook proved after issuing a disappointing earnings report.

“There probably is more risk in a narrow market, at least for those stocks that are part of the narrowness,” says Ken Crawford, senior portfolio manager at Argent Capital Management. “You’ve got a lot of money moving in one direction, which in the case of Facebook was out.”

There’s no ceiling on valuation, as Apple showed Thursday when it became the first company with a market capitalization of $1 trillion. Crawford points out, though, that Apple is the most reasonably priced of the FAANG stocks, with a price equal to just 17 times its most recent four quarters of earnings.

Amazon, on the same basis, trades at 163 times earnings and Netflix at 142 times earnings. Crawford says those prices “have me scratching my head,” while Apple’s ascent “makes much more sense.”

Joe Terril, president of Terril & Co., makes a distinction between stocks that rise because of strong fundamentals and those that are driven up by momentum traders. “There’s a trap door under some of these stocks if investors change their minds,” he said. “The old saying is that they go up on a staircase but they go down on an elevator.”

Terril thinks of Amazon, Netflix and others, including Tesla, as “leap of faith” stocks. They don’t earn enough money to justify the high stock price, but investors are betting that they’ll be hugely profitable someday. Facebook and Twitter, which also lost 20 percent of its value in a single day last week, are examples of what happens when that faith is shaken.

Could the next FAANG disappointment spark a wider sell-off?

That’s a danger, but Terril thinks we’re more likely to see a shift in market leadership. He sees money gradually rotating out of some of the overpriced stocks and into mundane industries like banking, airlines and energy.

“Those types of value stocks have been very reasonably priced while this market has been dominated by the FAANG stocks,” he says.

Juli Niemann, an analyst at Smith Moore & Co., compares such a rotation to a game of musical chairs. Some of Wall Street’s favorite places to park money may get pulled out of the game, but she says investors who are broadly diversified don’t need to worry.

With a healthy economy and strong corporate profits, she says, “the music certainly hasn’t stopped.”