Many of us regretted not going all in on tech after the market fall in March. The good news is that it might not be too late to start investing in growth stocks, and tech stocks more generally. Here is why.
Key takeaways on Big Tech
- Big Tech outperformed markets in 2020, pulling the S&P 500 up to a 16% gain for the year.
- Towards the end of the year, there was a rotation towards value stocks which lasted months.
- Not all FAANGs are doing so well in 2021 as some were doing better in a pandemic situation.
- Investment in tech is only beginning, and more potential gains lie ahead.
Reminder of what happened in 2020
Last year, FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) took a commanding lead in the markets and their growth was a phenomenal one. After the downfall of March 2020, FAANG stocks were the quickest to recover among the broader market, pulling the S&P 500 with it to a 16% gain for the year.
In a week in April, FAANG stocks single-handily added a quarter trillion dollars to the global market value. Naturally, investors went for the stocks that were the least affected by the pandemic and kept working at full speed despite lockdowns. Apple shares climbed 81% in 2020, Amazon shares soared 76% and Netflix shares gained 67%. Facebook was up 33% and Alphabet Class A 31%.
FAANG Stocks performance in 2020 (Source: TradingView)
FAANG stocks saw their business less affected than non-technology stocks, and their future growth became even more important with lower interest rates. As a reminder, a growth stocks is the stock of a company that generates substantial cashflow and which revenue is expected to grow at a faster pace that other companies in the industry. Growth stocks are mostly going to be tech-related: technology, discretionary, and communication services.
Value companies typically have low price-to-book values, high dividend yields, and low price-to-earnings ratios; growth companies have just the opposite. In other terms, value stocks are on sale, and growth stocks sell with a premium. To put it more simplistically, value stocks will mostly consist of financials, healthcare, industrials, energy stocks.
In 2020, the Russell 1000 Growth ETF which tracks the top growth stocks in the Russell 1000 Index was up 37% for the year, far ahead of the Russell 1000 Value Index which lagged with an almost comic 0.1% gain – and tracks the top value stock of the same index.
Growth stocks outperforming value stocks in 2020 (Source: TradingView)
The end of the rally at the end of the year
In November 2020, dynamics changed. The economy was recovering, and vaccination trials seemed to be a success. Investors took their eyes off the stocks that made Americans’ lives better during lockdowns and had the leisure to broaden their field of exploration, eyeing value stocks which traded at a discount, both for lack of attention and previously, a poor economic situation. These stocks tend to be more sensitive to economic recovery and went on a months-long rally as the economy turned back on. Funds went back to sectors such as financials, healthcare, industrials, energy.
March was the month where value stocks beat growth stocks by the widest margin we have seen in two decades. However, these gains have eroded recently leaving room for growth stocks, mainly in the technology, consumer discretionary and communications services sectors.
How are FAANG doing this year?
While some stocks like Alphabet Class A and Facebook fare well, with a 37% and 21% growth respectively year to date, other names are not doing so well. Amazon shares were only up 7.1% in 2021, Apple was down 1.7% and Netflix slipped 7.4%, which poorly compares to a 11% rise for the S&P 500.
In 2021, not all FAANG are equal, with some performing better than others (Source: TradingView)
Facebook and Alphabet are doing particularly well, most likely because their business model can be as profitable in a pandemic or non-pandemic situation. Facebook’s earnings last quarter nearly doubled from a year earlier and Alphabet’s earnings more than doubled. Many businesses are reopening and need attention, so where do they go? Most run to Facebook and Google ads. Both companies could profit from a surge in advertising.
Netflix most likely had the worst time in the recent months. Unsurprisingly, the company disappointed investors when it reported that subscriber’s growth was slowing down as the economy was reopening. Indeed, it is extremely difficult to replicate a subscriber’s growth to a streaming service happening when the world is stuck at home in a context where people only want one thing: to get out.
However, with many options available in a recovering market, investors are not as willing to pay a premium for cool tech names. Especially when rates rise, the premium priced in high tech valuation becomes much less valuable. As a result, FAANG have overall become less expensive than last year. For example, Amazon’s per share profit over the ensuing 12 months rose 40% since December, while the stock price rose by only 7.1%, which leaves investors with a forward price to earnings multiple of 55 instead of 73.
The same goes for Netflix, which had expectations for high forward earnings and a stock declining in price, which led to a contraction of its P/E to 43 from 60. Apple also saw its ratio go down, from 33 to 25.
Price-to-earnings multiples lowered for the next 12 months (Sources: FactSet, WSJ)
What is also interesting to see is that technology stocks which lagged in 2020 are now catching up, as we can see with Cisco, up 16% this year, and Intel Corporation, which gained 12%. It seems that many tech names that were left aside are joining the rally, and that investing in the top ten companies will not be enough to build higher returns this year.
Is Big Tech still a good strategy against market volatility?
Recently, inflation risk is scaring more than one investor. Consumer savings, in conjunction with an aggressive government spending policy has flushed markets with liquidity, increasing consumer price indices.
There are mixed views on the impact of this potential inflation on the market, especially on growth stocks. While some believe that it will only be transitory, some fear that if the Fed does not tighten its policy quickly enough, it might become harder to control.
Growth stocks – and especially tech – were kings in 2020, but they could now be threatened by inflation. We should also note that Big Tech could capitalize on trends that won’t be so strong in a post-covid world. Investors must be aware of a higher volatility potential and should make sure to diversify and include value stocks as well as inflationary defensive assets such as gold or defensive stocks in their portfolio.
One mistake, though, would be to pull out of tech stocks and other growth stocks entirely, as this could potentially kill returns or growth strategies. Despite recent gains and corrections, the fact is that tech stocks – driven by new disruptive technologies that will transform more than one industry like artificial intelligence, the Internet of Things, 5G and others – are poised for important gains over the next years.
The ridiculous size of FAANG companies, backed by solid fundamentals, is also responsible for their growth and resistance to market volatility. In other terms, these stocks could even potentially be a safeguard to hedge one’s portfolio from inflation. GAFA especially, did not fail to impress with their 2021 results either. Despite falling adoption rates in a recovering world, these companies still receive massive love from their users who barely could do without them.
Market pullbacks following inflation fears could potentially make great opportunities to bulk up on growth stocks with strong fundamentals. Market volatility is certainly a risk in such an unstable time, but long-term investors who look at the fundamentals and the market potential of quality growth companies stands to succeed in building a sound portfolio.