Equities: FAANGs and Tech Stocks
Only a few stocks helped US stock market indices to climb.
A good performance of US indices thank to FAANGs
A few rising stars, known by the acronym FAANG (Facebook, Amazon, Apple, Netflix, Google), helped US stock market indices to soar. In less than a decade, these few companies represented the top market capitalisation companies in the S&P 500 index (Apple leads the pack, followed by Amazon, Alphabet, Microsoft and Facebook). In 2009, the index leaders were ‘old economy’ companies, namely and in order: Exxon, Wal-Mart, Procter & Gamble, Johnson & Johnson and Microsoft. Radically transformed in the space of a decade, the US stock market has fully benefitted from the rapid digitalisation of the world economy. The FAANGs now account for 12% of the total market capitalisation of the S&P 500 index, versus barely 8% at the beginning of 2016. The performance gap between the S&P 500 index with and without the FAANGs has widened in recent quarters. Even during periods of uncertainty, the FAANGs are perceived by investors as safe havens, offering (usually solid) growth prospects, and potentially available cash for shareholders (via mostly share buybacks).
However, the concentration of the US market's performance, generated by a handful of stocks, calls for a degree of caution. Year-to-date, the S&P 500 index has gained 136 points (nearly 5.4%), with Amazon making up for 40% of this increase! Furthermore, certain FAANG stocks are trading at high valuation multiples (price-to-earnings ratio of 140 for Netflix for the 2018 tax year). Therefore, investors are not immune to disappointment (e.g. lower sales growth or squeezed profit margins). The recent drop in Netflix and Facebook is one such example. Finally, the implementation of new regulations for activities of these new mega-caps poses a potential risk. There is no certainty at this stage, but fears of a stricter control of their activities (in the wake of the Facebook scandal), or of any measures against their potentially monopolistic position are likely to harm investor appetite.
What is the outlook for the Technology sector?
In addition to this exceptional enthusiasm for a few Internet stocks, what is the general opinion of the technology sector? Growth is intact, underpinned by long-term opportunities in very diverse areas. All technology subsectors (i.e. semiconductors, hardware and software) are benefitting. Semiconductors are enjoying strong demand in different segments (robotics, auto, smartphones, etc.) while software and services are supported by the surge in data management (big data). The resulting earnings growth is robust, still at two digits.
However, following the fantastic performance of the sector (+26% in 2017), we prefer to be neutral. The free cash flow margin of tech companies, on the rise in recent years, is driving the sector's performance. It now stands at an historic level of 30% in the United States. Today upward potential seems more limited. Although the sector valuation is not excessive, it still justifies a neutral opinion. The sector's price-to-earnings ratio is 18 in the US (21 in Europe) and close to a two-year average.
Finally, an escalation of trade tensions between the United States and its trading partners could have negative consequences on the sector whose value chain has become extremely international. Semiconductors would be the first to be hit. Amid this uncertainty, we prefer to maintain a neutral view.