Underdeveloped regulation of internet and social media markets permitted category dominance for Facebook, Amazon, Netflix, Alphabet (Google), Microsoft, Apple and Tesla (FANGMAT). Now, aggressive valuations and threatening anti-trust action present a conundrum for investors. Should technology stocks still be bought on pullbacks and remain core holdings as I’ve previously recommended? It’s time to revisit the strategy.
The seven technology stocks are like the one-decision, buy-and-hold “Nifty Fifty” of the 1970s (not to be confused with the “Nifty 50” Indian stock index created in 1996). Nifty Fifty companies such as Polaroid, McDonald’s and Xerox (see Table 1) paced U.S. economic growth for half a century. Similar to FANGMAT stocks today, valuations seemed high but portfolios underperformed without them.
The Nifty Fifty appear more diversified than FANGMAT, representing industrial, consumer, health care and IT. However, FANGMAT subsidiaries are involved with hardware, cloud computing (Amazon Web Services and Microsoft Azure), food (Whole Foods), entertainment (Amazon Studios), AI (Alphabet’s DeepMind), autonomous vehicles (Alphabet’s Waymo), lithium-ion batteries (Tesla’s Gigafactory) and software development that has led to powerful positions in search, advertising, media and internet services. Diversification has been internalized.
FANGMAT stocks are the modern “blue chip” equities dominating today’s market performance. They are the seven most heavily weighted (22%) stocks in the S&P 500. Passive investors must also pay attention. At the end of 2020, the S&P 500 price-to-earnings (P/E) ratio of 38.2 was approaching dot-com bubble levels. At 30.6 at the end of April, the ratio remains at the higher end of its historical range.
Some technology stocks have high P/Es. Table 1 compares the multiples of the top 20 technology stocks (including other sectors similarly aligned) with those of a consensus Nifty Fifty top 20 from 1972. The multiple of the S&P 500 was 19.2 in 1972 compared with 32.8 today, but the Nifty Fifty multiples were uniformly more than two times higher than the index’s. Technology stocks, 26.6% of today’s S&P 500, skew the index’s multiple (Tesla in particular).
The Nifty Fifty underperformed the broad market once the bear market started in the 1970s and continued to underperform for 29 years, according to a 2002 article in The Journal of Investing by Jeff Fesenmaier and Gary Smith. The ultimate demise or reorganization of Polaroid, Eastman Kodak, Avon Products, Kmart and others is a warning to growth stock investors. Business climates change faster than many corporations can adapt.
Table 1: Comparative P/E multiples — Top 20 technology+ stocks in S&P 500 (April 2021) versus Nifty Fifty consensus top 20 (1972)
|S&P 500 Top 20 tech+ *(FANGMAT)||P/E||P/E||Nifty Fifty top 20 consensus (1972)|
|*Netflix||53.6||75.8||International Flavor & Fragrances|
|*Alphabet (A + C shares)||38.9||61.9||Johnson & Johnson|
|Texas Instruments||28.3||51.8||AMP Incorporated|
|27.8||50.5||Black & Decker|
|Comcast (A shares)||24.6||50.0||American Hospital Supply|
|S&P 500 (April 30, 2021)||32.8||19.2||S&P 500 (1972)|
|FANGMAT (cap weighted P/E)
|82.7||62.5||Nifty Fifty top 20 consensus (1972) average|
Source: Bloomberg (12 months trailing as at April 30, 2021). There is no official Nifty Fifty list. Listed here are 20 stocks common to Morgan Guaranty Trust and Kidder Peabody lists as identified in “The Nifty-Fifty Revisited” by Fesenmaier and Smith.
Global concern over the power, size and control of the FANGMAT companies is rising. Australian laws requiring Google and Facebook to pay publishers for news content and lawsuits filed last year against both are the tip of several icebergs. The European Union’s proposed Digital Services Act and China’s US$2.8 billion fine of Alibaba signal change for tech behemoths. U.S. President Joe Biden’s nomination of known big-tech critic Lina Khan to head the Federal Trade Commission — which administers federal anti-trust laws — has investment bankers scurrying in anticipation of an M&A and divestiture feeding frenzy. Investors should take this activity as a signal to reassess individual businesses.
If inflation expectations rise enough to increase the rate at which earnings are discounted — if 10-year U.S. Treasury yields rise over 4% by 2022 — P/E multiples may be forced lower by 20%.
Regardless, technology will continue to have an increasing role in how the economy functions. Although productivity gains measured by economists have been slowing for decades — a combination of a shift to a service economy and falling labour participation rates — technology’s role in global economic and environmental change will accelerate.
Canadian investors need to find diversified ways to participate in this growth regardless of anti-trust breakups that may threaten the technological hegemony of key players. More diversification means lower IT concentrations in the indices chosen. There are always ETFs with focused technology exposure for those looking to add volatility to their portfolios.
IT and FANGMAT weights in major indices are shown in Table 2. Advisors must decide how to best access technology and whether FANGMAT stocks should be a greater or smaller proportion of that exposure. For new money or investors who feel they have missed the move, choosing one of the two U.S. total market indices shown below may be a good way to get broader market coverage while still getting about 25% IT exposure.
Table 2: Technology and FANGMAT exposure by index (April 30, 2021)
|S&P 500 Equal Weight||505||15.1||1.2||27.5|
|S&P US Total Market||3,612||24.4||20||30.9|
|CRSP US Total Market||3,754||25.5||18.1||33.8|
|NASDAQ 100 Equal Weight||103||41.7||7||na|
Source: Index providers, Bloomberg, ETF sponsors, PŮR Investing Inc.
Mark Yamada is president of PÜR Investing Inc., a software development firm specializing in risk management and defined contribution pension strategies