The dominance of FAANMG stocks – and why investors should be wary

It’s not unusual for the US stock market to be driven by the performance of a few big growth stocks. However, they are generally scattered across different parts of the market, where they can independently develop sector dominance.

This time it’s different, according to a research note published by Bianco Research, which says that the market rally sustained since the beginning of 2018 has been driven by six companies in one sector: technology.

The total value of FAANMG stocks – collectively worth $4.5 billion – has, at times, overtaken the beleaguered UK stock market, in terms of size

They are generally known as the FAANMG stocks – Facebook, Amazon, Apple, Netflix, Microsoft and Google.  

According to Bianco: “This is unprecedented. When these stocks are removed from the equation, the last sixteen months would have seen the rest of the market underperform Treasury Bills. Globally, the non-disruptor MSCI World Index is still at a loss.”

The long term impact on index returns from an elite collection of large caps has been researched by Hendrik Bessembinder of Arizona State University. He analysed returns from the US equity market since 1926 and found they were driven by 4% of its stocks, with the remaining 96% matching Treasury bills.

The total value of FAANMG stocks – collectively worth $4.5 billion – has, at times, overtaken the beleaguered UK stock market, in terms of size. If you throw in Twitter, Tesla, Alibaba, Baidu, Nvidia and Tencent, to create twelve global disruptors, you get to a total worth of $5.3 trillion, not far from the scale of the Japanese stock market.

This, in turn, harks back to the 1980s Japanese boom, when Tokyo’s Imperial Palace grounds were said to be worth more than all the property in California.

There are good reasons to be impressed by the impact of technology across society. And the Federal Reserves’s decision to defer rises in interest rates to prop up the rest of the economy has been keeping funding costs down.

It is strange to see such enthusiasm for such a small number of stocks in the same sector which have yet to pay a meaningful dividend. But bubbles do strange things to the mentality of investors, desperately keen to believe their shares are still worth owning.

Tesla has just announced plans to raise $2.7 billion by selling equities and bonds, but saw its shares jump immediately after, as investors expressed relief it had found many were prepared to buy them.

If the stock market holds up, tech-driven car hire firm Uber, is planning to raise $10 billion in an IPO, despite never making a profit. Shares in its rival, Lyft, have dropped 20% since its IPO earlier this year.  Cloud computing provider Slack Technologies and leisure group Airbnb could be next to try their luck. Electric scooter companies are also dusting down float plans, despite the failure of highway authorities to welcome their plans. No one seems too concerned about these, and other, tech stocks lining up to part investors from their cash.

Time and again, the promise of scale is being used to peddle companies burning through cash. Unprofitable stocks are launching at the fastest rate since the peak of the Dotcom bubble of early 2000.

Over $1 trillion has been added to the US tech sector so far this year. According to Bianco: “Even with tech valuations at levels never seen before, the sector is seeing more interest than any other.”

Warren Buffett’s Berkshire Hathaway has been reluctant to buy tech stocks over the last five years. It capitulated and bought Apple in February 2017.  Now, it is buying shares in Amazon.

FAANMG stocks now have a weighting of 17.8% in the S&P 500, to which you can add companies exposed to their disruption.

Their scale, and growth, means passive strategies have never found it so easy to score points over rival active managers, reluctant to place such large bets on single sectors.

But it can’t last. Can it?