Justin times

Choosing between America’s fangs and the Asian dragons

12 Jun 2017

Justin Urquhart Stewart, Co Founder and Head of Corporate Development

In this article featured in What Investment, Justin talks about FANG & STAT stocks as well as it's impact on the markets

Article featured on What Investment and published on 9th June

There’s a debate ranging about the record highs that the S&P 500 keeps hitting. The rally post the election of Donald J. Trump saw the US stockmarket rise rapidly. Overt promises of deregulation, combined with the inviting prospect of big tax cuts and even bigger infrastructure spending, would jumpstart the US economy beyond its recent 2.something percent GDP growth range.

Since that date, the S&P is up 14%. Discounting election euphoria and looking only at 2017 year-to-date performance i.e. when something could have actually happened, the S&P 500 is still up – by some 8%1 - which really is quite extraordinary given nothing has actually happened! So what’s fuelling that growth? Certainly not US GDP which in Q1 this year disappointed with a figure of 0.7%, marking the slowest growth in three years.

The answer lies in the tech sector and specifically the ‘FANG’ stocks i.e. Facebook, Amazon, Netflix and Google (or Alphabet Inc to give its listed name). These four are up some 28%. And while we’re not in the business of recommending stocks, it’s interesting to see the contribution they’ve made to the overall S&P 500 as removing their ‘contribution’ leaves it ‘only’ up by around 1.4% − a much more likely result. Together, these four firms are now valued at more than US$1.6 TRILLION1 – to put that into perspective, that’s about the same as the entire Russian economy. And tech stocks ‘bailing out’ the rest of the index isn’t new – the four also led the market in 2015.

Digging into the detail, the news does not necessarily reincarnate ghosts of the 2000 dot.com tech bubble. There actual achievements (i.e. the boring stuff such as revenues and profits) became increasingly divorced from valuations until investors came to the crashing realisation that brand didn’t necessarily mean big business.

Now, there's a good case that these businesses have developed some quite substantial set-ups.  All four are subtly different, but their activities overlap by quite a lot. Facebook and Google mainly make their money from advertising – some 20% of total global advertising spend to put a figure on that. Whether you’re searching for information or catching up on your friends’ activities and the odd cat video, these companies get paid to get company names and products in front of you. Netflix and Amazon meanwhile both compete to get viewers for their videos, while Amazon and Google also compete to direct shoppers to products which provide a percentage of their profits back to these two behemoths. It all becomes even more complicated when you dig into the back-ended businesses run by the fangtastic four.

It should also be noted though that these stocks have become a bit of a self-fulfilling prophecy now they’re in fashion. Not only is the tech industry one favoured by many a hedge fund, the weighting of the stocks means that they have to be automatically included in significant amounts in other investment funds just because of their size. This is where any memories of the tech bubble should urge caution − as enthusiasm gathers more and more momentum and their apparent strength becomes unstoppable…

So this could be the time for a little scepticism. Markets have moved with great serenity over the past few months, despite the twittering fantasies of the US presidency. Most economies around the globe have benefited from lower oil prices and growing demand from both companies and consumers. The VIX or volatility index (that measures by how much stock prices fluctuate) seems almost flat and the so-called surprise indices have become almost becalmed. This means that there are few opportunities for new investors to get on board.

And, while there still seems to be momentum behind these companies to drive them further forward, at some stage the situation will start to unwind. Some have already indicated that they believe that we are in the first stages of an overshoot.

Unfortunately, none of us know for sure when that moment could come and what sudden shock could create a potential buying opportunity, but what we can do is to start to be prepared. While we cannot predict market movements, we can prepare for a surprise summer sale.

In addition, investors can also start to look further afield. And following one of the most important tenets of investment in diversification, you can look at four Asian Dragons namely the ‘STAT’ stocks of Samsung, Tencent, Alibaba and Taiwan Semiconductor. Their growth potential is looking to tap into the much longer term story of Asia’s burgeoning middle classes versus the more mature Western markets. And Asian consumers are seen as more rapid adopters of new technology than their Western peers.

Of course, investments can go down as well as up and you could get back more than you originally invested. However, there is the chance here too for these stock serpents to provide enough fire to breathe growth into the MSCI Asia Ex. Japan Index. The tech industry is now the largest sector within the index and is at much more attractive Price/ Earnings ratios than its American contemporaries.

Justin Urquhart Stewart
Co Founder and Head of Corporate Development

IMPORTANT NOTE: 7IM may hold positions in some or all of the securities mentioned here either directly or via the third party funds in which we invest. The article is not intended to provide specific stock or investment recommendations to individual investors, but rather highlight how index performance can be influenced by its largest holdings and so you may be less diversified than you originally thought.

1 to the week ending 2 June 2017

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Important information: The information contained in this document does not constitute investment advice and it is not an invitation or inducement to engage in investment activity. The value of investments, and the income from them, can fall as well as rise and you may not get back the full amount invested. Seven Investment Management LLP is authorised and regulated by the Financial Conduct Authority. Member of the London Stock Exchange. Registered office: 55 Bishopsgate, London EC2N 3AS. Registered in England and Wales No. OC378740.

The value of your investments and the income from them may go down as well as up, and you could get back less than you invested.
The value of your investments and the income from them may go down as well as up, and you could get back less than you invested.

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