The FAANG (Facebook, Apple, Amazon, Netflix, and Google) stocks have been in the news quite a bit recently, with all of them in correction territory (a drop of at least 10%) since their respective peaks this year. These five companies make up more than 10% of the S&P 500 Index, and were the belles of the ball until recently, generating a cumulative return of 89.3% from the end of 2016 to the most recent market peak on September 20th. At APCM, we focus on asset allocation as the primary driver of returns, but we monitor specifics in the markets as early indicators of economic conditions to determine if changes to our outlook is warranted.
Group Woes
The FAANG companies in general share some commonalities that affect all of them. They are all generally considered companies that generate revenue from technology or through inventive use of technology (like Amazon changing the way we shop, or Facebook changing how we communicate with friends and family), and each has shown market dominance in their respective markets. They also generate a relatively large portion of their revenues from international sources. Given the recent global growth slowdown, investors began reevaluating each company’s prospects for the future.
Expectations for global growth have begun to slow from peak levels reached this year, especially outside the U.S. We’ve all seen the headlines about slowing growth in China, slowing growth in Europe, and the expected effects of the current trade tensions that have been building higher and higher all year. Each of these has had an impact on the outlook for the FAANGs, as demand for their products overseas is lessened by slowing economic growth. In addition, the U.S. Dollar is up over 6% this year, which makes U.S. goods and services more expensive for the rest of the world (or if the company leaves prices as they are, the company receives less revenue).
Company Woes
On an individual basis, these companies have been in the news since late September for one reason or another.
For Google (Alphabet Inc.) and Facebook, the problems have stemmed from possible new regulations and scandals. Google has faced fines and increasing regulatory scrutiny, especially in Europe where the company has been fined a record $5 billion. Facebook has seen multiple scandals this year, the most recent scandal prompted by The New York Times feature regarding the company’s response to the activity on its platform linked to Russia. Fears are that continued scandals and increased regulation will hurt both companies in the near-term and possibly be a long-term headwind to revenue growth if new regulations are burdensome
Apple and Amazon have both come up against worries that consumers are not going to be consuming as much in the short-term. Apple recently scaled back orders for production of the new iPhones, and Apple suppliers have reported lower than expected orders for hardware used in high-end mobile phones. Amazon’s third quarter results fell a little short of expectations, but for a company that had a P/E Ratio almost 60 times forward earnings as of September 20th, any failure to meet expectations can have significant consequences.
Did the Music Stop, or Did We Just Hit Pause
Starting the year, APCM’s 2018 outlook was “cautiously optimistic” to acknowledge strong economic growth and corporate earnings, offset by late cycle risks and escalating trade tensions. Currently, global growth is slowing, but we need to remember that it is still expanding. Despite slowing economic growth, odds of a recession in the near-term remain low. APCM has also been watching the unfolding of trade tensions as a risk to our outlook. Recently, FactSet reported that fewer companies are citing trade tensions as a concern relative to second quarter earnings calls.
Offsetting Apple and Amazon’s concern of slowing consumer demand, APCM notes strong consumer balance sheets, low unemployment, and rising wages are supportive of consumer spending. Additionally, Amazon’s Cyber Monday sales were a record-breaking $7.9 billion this year. These indicators of a health consumer and continued economic growth lead APCM to conclude that, while uncomfortable, the recent market volatility is due to investors repricing risk based upon slow economic and earnings growth expectations going forward.
The regulatory and scandal-based problems at Google and Facebook are concerning and need to be monitored. However, they do not constitute risks to the stock market in general. They are specific to those industries and companies. Since APCM’s investment process puts a heavy emphasis on prudent diversification, no single company or industry has an outsized impact on portfolios. Instead, we focus on building a plan to help clients meet their specific investment goals driven by expectations for asset classes as a whole, regardless of individual stock performance.
Vinay Sharma, CFA®, CIPM®
Senior Investment Analyst
11/28/18
