FAANGs for the Memories

Lately the FAANG gang (Facebook, Apple, Amazon, Netflix, Google) is feeling the brunt of the market. With public mistrust and regulatory scrutiny threatening their freedom, serious risks loom for the FAANGs. But are these price shocks company-specific or a macro issue? Within HiddenLevers, the Tech Bubble scenario lets us explore how these macro conditions affect the market.

Given FAANG market volatility today, an early 2000s Dot Com bust is a distinct possibility.

Both FAANGs now and the tech titans then exhibited unprecedented growth. But drivers between the early 2000s and today are starkly different. The Dot Com era was the advent of the internet and the market was flooded with overvalued speculative investments, which led to major selloffs that sucker-punched the market.

Today tech is interwoven into both markets and daily life, and the technology sector once again has the largest sector weight in the S&P 500. The consequences of mismanagement could be the undoing of FAANG stocks and possibly end the market’s bullish run.

For Facebook, the data for over 87 million users was harvested through a loophole in the platform’s API and later used to influence voter opinions at the polls. Facebook’s privacy violations and misuse of user data hit the company’s stock hard last month as investors feared government regulations. Similarly, Amazon took a hit after President Trump tweeted about stronger regulations. Regulatory threats could continue to scare investors into offloading tech stocks.
Then there’s Tesla, whose Teflon armor was pierced after it missed Q1 production targets and suffered another fatal Auto-Pilot crash. CEO Elon Musk tweeted Tesla was bankrupt as an April Fool’s joke, but many hedge funds are betting that bankruptcy is in Tesla’s future if they cannot solve production problems.

Though the Trump administration has gained a reputation for cutting rather than creating regulations, regulations against tech aren’t farfetched. The administration blocked Broadcom’s bid to take over Qualcomm, and banned US tech component sales to ZTE, a Chinese smartphone maker. It has also pushed to require sales tax collection by ecommerce players like Amazon. Billionaire investor Jim Mellon noted tech stocks would be “pillaged” by administrations around the world for misuse of data, calling out Facebook and Google as “fatted calves…ripe for the plucking by governments everywhere.”

Screen Shot 2018-04-18 at 3.47.53 PM.png

Despite their perceived invincibility, the FAANGs and other tech giants are vulnerable to a hard fall. FAANG stocks sold off hard before the 2016 election, more than doubling the S&P 500’s downside. Though FAANG stocks have since rallied to new heights, anxiety over a FAANG-led market correction now leaves many investors on edge. Those anxieties are now peeking through as FAANG valuations diverge from CAPE – a potentially frothy situation.

Screen Shot 2018-04-18 at 3.49.26 PM.png

As the chart above shows, FAANG price growth and CAPE growth have been strongly correlated – a divergence could be an indicator of excessive valuations. The current bull run is among the longest in history, and market volatility reminds us that bull markets often end abruptly.

Along with the valuation reality check, tighter regulations could dampen the extreme bullishness on the FAANGs. FAANG stocks will survive regulations, but may not be able to dominate to the same degree. Regulations could hinder the social media and online ad business model, where user data is the core product. Moreover, indebted tech companies like Uber could be hung out to dry if capital markets tighten.

It’s not all doom and gloom – Spotify, Roku, and Dropbox have had strong IPOs, signaling large tech firms like Airbnb to do the same. Perhaps these tech protégés will learn from the mistakes of their FAANG predecessors. But at the end of the day, runaway valuations always have their reckoning.

Sign up for a HiddenLevers account to see how your models and portfolios might look under different outcomes of the Tech Bubble scenario.

 

 

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