Friday, 19 October 2018

Is the FAANG too big to handle?

The FAANG-stocks (Facebook, Amazon, Apple, Netflix and Google) have rallied in the US stock-market for the past years. From those Apple, Google and Amazon are currently the biggest public companies in the world measured by market capitalization.

The valuations of the FAANG-stocks are huge and together they compose 13 % of the S&P 500 index. They are the main reason why S&P 500-index was up 2,6 % in the first half of 2018. Without FAANG, the total return would have been -0,7 %. 

Many investment funds investing globally and to the US have been enjoying the ride throughout 2018 and shown promising graphs for the investors. A small comparison can be illustrated below:

The graph above shows us three example index-funds from Nordea: Global Passive Fund, the European Passive Fund and the North America Fund. The Benchmark describes the return of the MSCI World Total Return NTR from the past 6-months. As we can see, the Global fund has performed better than the European one from the mid of May. Also interesting observation is that when the spread between the European and the Global index-funds has been increasing, the holdings of the North America Fund have outperformed the global index. My hypothesis is that this is all due to the rapid growth of the FAANG-stocks during 2018.

That also creates a concern for the index-investors. If you buy the extremely popular iShares Core MSCI World UCITS ETF (EUNL) or not to mention the iShares Core S&P 500 UCITS ETF (SXR8), you are highly exposed to the movements of the FAANG-stocks since they form the biggest share of holdings of these index funds.

Netflix released its Q3 earnings a few days ago. A company of $4bn in net debt still possess a net debt/EBITDA of only 3,2 years. In the same time the free cash-flow has been estimated to be as negative as -$3bn. Especially the debt burden has already made several Wall Street-analysts to cut their price targets for the company and question the sustainability of the growth. Apple reported its astonishing Q3 in August and Amazon, Google and Facebook are reporting their Q3 earnings in the following weeks.

I have to say that I´m always a bit skeptical when someone mentions “easy-money” or “almost risk-free investment”. These are the words that I´ve heard from the FAANG-stocks lately. “If Apple and Amazon have grown so rapidly, no one can stop them, and they keep on growing and owning the planet with their data.”

We all should know that this isn´t a universal truth. How long can the growth continue? No-one really knows. Rapid growth can introduce risks that investors and the shareholders could not know yet. Already U.S President Donald Trump has been furious towards Amazon and some regulations have been planned to slow down Amazon based on lowering barriers to entry and increasing competition in the market.

The big question is: Are the FAANG-stocks already too big? 5 companies in the same sector already have a significant contribution to the global stock market and their movements contribute to the stock indices all over the world. If something negative happens with these companies (etc. a big crash), we are going to see significant echoes all over the global financial markets.

Being honest, it is hard to see what could be the thing that could drop the FAANG-stocks fundamentally. They have a reason why they are the biggest companies in the world: Their core business is solid, and they have already proved their capability to innovate and to create disruption in their markets. The main thing is to note here that even with good diversification you might not be safe from the movements of the FAANG-stocks.

Even as an index-investor, you might have a higher risk-exposure to the FAANG that you might think.