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Why Now Is Not the Time to Invest in FANG

The market's four highest performing tech companies have earned their own monicker and our attention.

By Mark Matthews

Facebook, Amazon, Netflix, and Google—or FANG as they’ve been romantically referred to—have been atop the leader board in market performance for the last few years. As a result, investors have clustered into these stocks at a pace not seen in the technology sector since the late 90s and early 2000s. Correspondingly, FANG’s overall contribution to market performance has increased 8.5 times since 2012 (see graph below, data as of 6/12/17).

 

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This performance chasing has resulted in a herd-like activity that has consistently caused investors to buy in at market highs, completely ignoring the time tested adage of buying low and selling high. What the graph below will show is that since 2012, herding into FANG stocks has caused the individual securities to trade at a significant premium to the global market. But, as the famous portfolio manager Howard Marks puts it, “No group or sector in the investment world enjoys as its birthright the promise of consistent high returns.” Meaning outperformance isn’t permanent and the notion of mean reversion is almost inevitable. The tech bubble of the early 2000s is a perfect example of such a phenomenon. Investors vehemently poured into tech stocks during then, pushing the Nasdaq from around 1,000 points in 1995 to more than 5,000 in the year 2000. To feed this demand, new internet-based companies were popping up virtually every single week. The frenzy ended in an abrupt halt, however, as the Nasdaq cratered 78 percent after hitting its peak in March 2000. While there are stark differences between the year 2000 and the present that suggest such a downturn in tech is highly unlikely, there are striking similarities that point to the importance of diversifying your exposure rather than piling into an already crowded consortium of just a few stocks.

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Further, as economic conditions continue to tick up, although at a somewhat sluggish pace, the breadth of performance tends to expand and a larger number of companies will offer gains in the market place. Additionally, an economic environment gaining steam is conducive for wider dispersion, an environment prime for stocks exhibiting value characteristics. These characteristics include low price multiples—companies typically trading at discounts as opposed to premiums to the overall market, high cash flow yields, and strong fundamentals. Strengthening the argument for a value led market is the previously mentioned concept of reversion to the mean. Markets have experienced an extended period of growth outperformance relative to value over roughly the last decade with the exception of a reversal to that trend realized in 2016. Value outperformed growth by just over 10 percent in 2016, led by the resurgence of sectors such as energy, telecom, and financials. As a result of growth’s outsized performance relative to value, value is as cheap as it has been in nearly 10 years.

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Perhaps the most compelling argument as to why this is not the most opportune time to invest in FANG stocks is developing innovation. Artificial intelligence, autonomous driving, machine learning and cloud storage have been the direction of investment cash flows in the technology sector. Productivity in artificial intelligence and machine learning has been fueled by the continued growth in areas such as the internet of things as developers continue to build devices, software, sensors, and network connectivity to enhance the consumer experience with elevated functionality. Momentum in autonomous driving has been incited by fierce competition, rapid acquisition and collaboration, and increased investment in software intelligence platforms. Suppliers of these capabilities stand poised for market outperformance as innovation sits at the forefront of future growth in both the near and short term. Where these developments then benefit stocks in the FANG category is when the technology in these respective areas has led to tangible products ready made for consumption. As these segments still remain in relative infancy, cash flows will continue to pour into places such as semiconductors (providing chips to develop aforementioned capabilities), software developers (developing platforms), and IT services (wide reach and customer relations) industries.

How should investors avoid the herd, position themselves for a value led market, and take advantage of developing innovation? Remain consistent in a disciplined process rooted in valuations, qualitative and quantitative analysis frameworks, and stringent risk considerations. By staying true to these principles, investors will be able to achieve competitive risk-adjusted returns, avoid valuation traps and significant market drawdowns, and benefit from smooth investment experiences overtime.

Mark Matthews is an Investment Research Analyst for CLS Investments

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