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Good morning. A nice bump for stocks on Friday after Jay Powell made some boring comments about the Federal Reserve being data-dependent. Markets, parched for good news, lapped it up. But chances are everyone will go back to being gloomy soon enough. Not hearing anyone calling bottom yet — just some halfhearted “tactical” buys.
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A Faangs value check-up
Despite all the gloom and doom talk — about how higher rates force long-duration assets down, a regime shift towards value stocks, and how big tech is reaching the end of its high-growth phase — the Faang stocks still matter a lot. Let’s have a look at how they have done this year:
Not well! Is a buying opportunity forming?
Two things to note at the outset. First, the Faangs are now technically the Faamgs. The streaming company may yet make a comeback, but its recent troubles have proven once and for all — to Unhedged, anyway — that Netflix is a media company, not a tech company, and does not belong with tech’s big dogs. Microsoft’s multiyear re-emergence as a cloud computing power, on the other hand, shows that it is perfectly at home among the four younger companies.
Second, Unhedged is still grouchily denying that Google now calls itself Alphabet and that Facebook goes by Meta. Google is still a search advertising company, Facebook is still a social network. We are not fooled by inane rebranding.
Why do the Faangs matter so much, and why should we be alert to a chance to buy them at a discount? To start with, they represent a fifth of the S&P 500, with a market capitalisation of $7tn. As they go, the market will (largely) go. Further, huge companies should be able to use their market position and abundant resources to defend their margins in tough periods such as the one we are sliding into now.
And despite all being tech companies broadly speaking, the Faangs are quite a diverse group of companies. Microsoft and half of Amazon (depending on how you slice it) are computing companies that cater to businesses. The other half of Amazon is a global (but quite domestically tilted) e-retailer. Google is a quite cyclical search advertising provider that caters to business. Apple and Facebook are thoroughly global consumer tech companies, one built around a dominant hardware franchise, the other around advertising against a no-longer-dominant but still immense social network.
They are all, with the arguable exception of Amazon, immensely profitable. They produce more free cash than they know what to do with. This means the argument (a canard at the best of times) that tech stocks must go down as rates rise cannot possibly apply to the Faangs. They likely derive as much of their value from near term profits as the oil companies, consumer staples brands and banks that fill up value portfolios.
A look at the five groups’ recent drawdowns, valuations and growth rates:
To my eye, the two of the five that have fallen the most still look the most expensive. The dramatic slowdown in growth at Amazon’s e-retail business may turn out to be temporary payback for its staggering growth early in the pandemic, but I do not fancy paying over 50 times earnings to find out. Facebook has a low price/earnings ratio and generates a lot of cash, making it look like a value stock, but does the market want to value it on cash flow? Or will the whippings continue until revenue growth (7 per cent in the first quarter) improves?
Of the other three, which would you want to own if we are heading for a recession next year? Google’s core business is quite cyclical. Apple’s is dependent on a fast-slowing China for a fifth of its sales. Microsoft’s strong position with business customers, by contrast, will be very appealing in a slowdown.
These are just generalities, of course. I think the overall point can be summed up by saying this: these are all remarkable companies, and while they are not cheap yet, they are a hell of a lot cheaper than they were, and the fact that the zeitgeist is now anti-tech should not discourage us from watching them closely as the current bear market plays out. There will be a moment to pounce.
Here is a useful contrast. The Faangs, in market cap terms, are numbers 1, 2, 3, 4 and 7 in the S&P 500. Here are numbers 8, 9, 11, 12 and 14, which will also enjoy all the advantages of being absolutely immense companies:
Here are a diversified healthcare company (in pharma, medical equipment, and consumer goods), the biggest health insurer, half of a payment duopoly, a vast value retailer, and a collection of strong consumer staples brands (Pampers, Tampax, Gillette, and so on). It’s a classic basket of defensives — yang to the Faangs’ yin. A neat acronym does not suggest itself, unfortunately (we’re open to suggestions).
The price/earnings valuations of the two groups are similar, and while the defensives’ recent growth has been weaker, outside of Visa, we could see a convergence in a recession. Also the lower volatility of the defensives is attractive (“beta” is a measure of volatility relative to the wider market, with “1” representing market volatility, 1.2 representing 1.2 times the market’s volatility, and so on). So far in this bear market, the defensives have outperformed, again with the exception of Visa (the S&P is off 16 per cent from its high).
(You may wonder what happened to numbers 5, 6, 10 and 13 in the S&P’s market cap ranking. They are Tesla, Berkshire Hathaway, Nvidia, and Exxon. They all have tricky features that made the comparison less tidy).
A challenge for readers. Over the next year, which basket will perform better, the Faangs or the defensives? The pessimist in me picks the defensives, but only over the next year or so. At some point, and it may be sooner than you think, it will be time to switch back to the big tech companies that have driven the market over the past 10 years.
Live by retail bros, die by retail bros
The easy money era has gone by, taking with it the retail investor moment. The FT’s Madison Darbyshire and Nicholas Megaw report:
Net retail inflows amounted to just $2.4bn this month to May 10, compared to $11bn in April and $17bn in March, according to data from JPMorgan .
The value of an average retail investor portfolio has declined by 28 per cent since late December as retail equity flows weakened in the downturn, according to Vanda Research. The data provider found retail sentiment to be “extremely bearish” .
Analysis of OCC data by Jason Goepfert of SentimenTrader suggests that retail traders are also becoming a smaller proportion of overall options activity. Small options trades [hit] a two-year low of 32 per cent [in April].
Getting rich off buying the dip is so 2021. Unsurprisingly, Robinhood and Coinbase, stock and crypto brokers to the YOLO end of the retail spectrum, have looked dismal compared to their more staid competitors (who have not been doing so hot themselves):
Part of the split reflects Coinbase and Robinhood shares debuting in frothy markets that overestimated their growth potential. But both firms are highly exposed to retail investors will little experience of big losses. Robinhood’s business is heavily dependent on options trading. Coinbase has tried to branch out to institutional crypto clients, but even still, 83 per cent of its revenue came from retail in the first quarter of 2022.
These are not defunct firms. Robinhood is experimenting with new features like stock lending, a promising sign it is trying to innovate. But a return to former glory will be very hard indeed. (Ethan Wu)
One good read
In his farewell column for the FT, John Dizard, with characteristic astringency, condemns private equity as a bunch of asset-gatherers and fee-collectors. He has a point. Farewell John!
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Source: Financial Times