The surging FAANG stocks are some of the world’s most highly valued companies and have led markets for over a decade, but Natixis Investment Managers’ Jack Janasiewicz thinks they are not expensive enough.
Comprising Facebook, Apple, Amazon, Netflix and Google, the FAANGs have been the vanguard of the US tech growth rally. Microsoft is another tech giant that is considered closely linked to this group and has also undergone a significant rally.
US mega-cap tech stocks have been the main drivers to the S&P 500 returns both before, during and after the coronavirus crisis, as investors have sought out high growth in low rate environments.
S&P 500 vs MSCI World over 10yrs
Source: FE Analytics
The resilience during the coronavirus crisis has meant that even more investors have piled into the FAANGs and their peers, pushing the companies’ valuations to record highs.
But Natixis portfolio manager Janasiewicz thinks that the FAANGs and US tech stocks, in general, aren’t expensive enough.
Janasiewicz said, given the quality of the companies’ earnings and the way they achieve them, they’re actually worth more than what investors pay for them now.
“One of the things which I tend to fall back on with regards to the valuation side of the story is that valuations are an opinion and opinions can be right and wrong,” he said. “You might think that the valuations of some of the tech stocks are overvalued and I might argue that I actually think that they’re undervalued, given the quality of the balance sheets.
“Given the kind of cash, no debt and buying back stock of some these tech companies, and having almost monopolistic style qualities, when I factor all those things in I might say they should be trading at a higher premium to the market.
“So maybe I would say, they’re not necessarily expensive.”
Combined, the FAANGs make up one-quarter of the S&P 500 index, indicant of the significant influence they have on the US market.
But this influence is paid off by the returns they make for the index, according to Janasiewicz.
He said: “They account for over 25 per cent of the market, but they’re also pulling in almost 20 per cent of total earnings of the S&P 500, so the quality of earnings are there and I think that’s also a key differentiating factor.
“These guys are putting up numbers and they deserve to have some pretty significant influence on these indices because they’re basically the winners in this whole backdrop.”
But, of course, not everyone agrees.
US tech has dominated global markets for the past decade, favoured by a low interest rate environment supporting growth style companies.
But earlier this month US tech sold off, with the MSCI ACWI Information Technology index losing 3.82 per cent during the first week of September.
Index’s performance 1-7 September
Source: FE Analytics
And the FAANGs were hit hard in this sell-off. Apple dropped by nearly 8 per cent, Microsoft over 7.5 per cent and Amazon was down 6.7 per cent.
This raised questions about how long these companies can continue exponentially rising and led to many asking if now is the time to move away from these dominant mega-cap names.
Luca Paolini of Pictet Asset Management thinks that this exactly what will happen across global markets over the next five years.
The primary reason for this, according to Paolini, is that US tech and the FAANGs led markets during the 2009-2020 bull market. But it has never been the case that the leaders have been the same over the next bull market.
“When you look at every bull market the leaders have always been different,” he said.
“The new bull market has just started just a few months ago, but it has never happened that the leaders of the previous bull market are the same in the next one. And this is why we feel that especially for US investors is a good time now to diversify away from US equities.”
A double sector rotation – out of the US and out of tech – isn’t just something US investors will be doing Paolini said, but could be seen globally.
US equities currently make up 70 per cent of the MSCI World index. Paolini said: “I think that this is where it doesn’t feel right. And I think that it’s probably the right time to diversify into other regions.”
Indeed, Zehrid Osmani of Martin Curie Investment Management argued that his Martin Currie Global Portfolio trust is proof that you don’t need to rely on the FAANGs to outperform.
While it is true that the FAANG stocks have been some of the big ‘winners’ the past few months, Osmani said his trust has outperformed its benchmark while being deliberately underweight the FAANGs versus his peers.
The only US mega-cap tech name in the trust’s top 10 is Microsoft.
Year-to-date Martin Currie Global Portfolio has made a total return of 16.31 per cent, outperforming the FTSE World index (4.91 per cent) and the IT Global sector (1.41 per cent).
Performance of trust vs sector and index YTD
Source: FE Analytics
Osmani said, that since taking over the trust in 2018 he has been wary “of the risks these companies faced” and has favoured options in the healthcare sector for strong returns.
“When it comes to analysing stocks, we look at the risks they bring, including industry risks, company risks and governance and sustainability risks,” he said. “Some of the FAANGs and their business models face potential risks related to competition, reputation and/or disruption in my view.”
In some cases, Osmani said he prefers to find opportunities “exposed to the same ecosystem these dominant companies operate in”, such as companies involved in the FAANGs’ supply chains for example.