From Barron's Up and Down Wall Street column:
A handful of heavyweight tech names drove the S&P 500 for months and produced a very crowded trade. On Friday, it may have come to an end.
Politics, schmolitics. The much-hyped events of last Thursday—former Federal Bureau of Investigation chief James Comey’s congressional testimony, the British election—turned out to be duds from the markets’ standpoint. The fireworks came on Friday, after a number of high-profile stock seers called time out, if not the end, on the mighty advance in the equity market, in particular the megacap technology stocks that have led the Nasdaq and most of the major averages to records.
The so-called FAANG stocks— Facebook (ticker: FB), Amazon.com (AMZN), Netflix (NFLX), and Google parent Alphabet (GOOGL)—with the second A added with the inclusion of Apple (AAPL)—had accounted for over two-fifths of the Standard & Poor’s 500 index’s gain in market value this year, The Wall Street Journal noted in a page-one piece on Friday. While pointing out that the rush into these big tech names was the most crowded trade anywhere, one money manager opined that it wasn’t about to end anytime soon.
Famous last words. Robert Boroujerdi, head of global securities research at Goldman Sachs, issued a report on Friday warning that the big tech stocks—including Microsoft (MSFT), which he added to make it FAAMG—had become way too crowded a trade. (The market caps of Netflix and Nvidia [NVDA] are too small to influence the cap-weighted S&P 500, he wrote.) The surge in FAAMG made for exalted valuations that recalled the Nifty 50 of the early 1970s or the dot-com era of 1999-2000, lifting them to lofty perches whence they could take a nasty spill.
But the FAAMGs’ steady ascent also had the counterintuitive effect of lowering the megacap tech stocks’ perceived risk to less than that of traditionally defensive sectors, such as consumer staples and utilities, Boroujerdi wrote in his much-discussed note. That’s because the big-cap techs’ steady ascent had lowered their volatility.
And just as truth is beauty and vice versa to poets, volatility and risk are the equivalent to those steeped in modern finance. A steady climb in a stock’s price makes it appear less risky. But megatechs’ low realized volatility can lead investors to underestimate the risks inherent in their businesses, such as cyclicality, regulation, or disruption. Then the volatility of FAAMGs could surge, leading to a reversal of the influx of money into the sector, Boroujerdi explained.
Investors weren’t waiting for that to happen. Apple, the world’s biggest-cap stock, shed a massive 3.9% of its value on Friday, contributing mightily to a 1.8% plunge in the Nasdaq Composite. Facebook surrendered 3.3%; Alphabet, 3.4%; Amazon, 3.2%; and Microsoft, 2.3%. That added up to a combined paper loss of over $97 billion that day in these supposedly low-risk stocks. To put that in perspective, Boroujerdi said their appreciation this year had totaled $600 billion before Friday’s haircut, equal to the gross domestic products of Hong Kong and South Africa combined.
Friday also brought a number of warnings from other Wall Street worthies. David Bianco, chief investment strategist for the Americas at Deutsche Asset Management, advised clients that the rally “has reached its near-term limits and is vulnerable to summer fatigue and rising anxiety over whether Congress can make pragmatic decisions.” That makes the next 5% move in the S&P 500 likely to be lower, he concluded.
Guggenheim Global Chief Investment Officer Scott Minerd wrote that “stock and bond markets have rarely been more expensive and stable, and that has me worried.” The apparent complacency “argues for caution” and “dry powder” to take advantage of opportunities as volatility picks up later in the year.
Yet amid the tech wreck, the S&P 500 shed just 0.08% on Friday and 0.3% for the week, while the Dow Jones Industrial Average ended at another record, up 0.42% on Friday and 0.31% for the week. That implies that money exiting the megatechs ended elsewhere, a lot of it apparently into energy stocks, with the Energy Select Sector SPDR exchange-traded fund (XLE) popping 2.41%—a sector, colleague Andrew Bary notes on page 15, that had become undervalued.
The rotation also found its way into banks and other financials, with the Financial Select Sector SPDR ETF (XLF) jumping 1.9% on Friday. Financials appear to be benefiting from a rollback of the Dodd-Frank regulatory legislation that passed the House of Representative on Thursday. An uptick in 10-year Treasury yields from their lowest level just after November’s election also gave a boost to banks and prospects for increased net-interest margins....MUCH MORE