Up until recently, US technology share prices were on a tear. For most of this year the so-called Faangs – Facebook, Amazon, Apple, Netflix and Google – added further gains to the 40% they recorded during 2017.
That all changed on October 9. The S&P 500 and information technology-heavy Nasdaq indexes experienced a market rout, falling by 3.3% and 41%, respectively, in a single day. By November 20, the Faangs had lost close to 20% against a 6.6% drop for the S&P 500.
The falling out of love with tech stocks was also evident in Bank of America Merrill Lynch's November global fund manager survey, which showed that only 18% of fund manager respondents were net overweight technology – the lowest level since February 2009.
The Faangs’ stock drops bring to an end a long period of market growth even as mounting regulatory and financial risks have tarnished the once-irresistible charms of these tech companies.
That is causing institutional investors to look with some alarm at just how much US stock performance has come to depend on the fortunes of tech titans that face their own obstacles. It could force some asset owners to rethink how they invest into stocks.
As of October, information technology stocks made up 21% of the S&P 500 and 44.1% of the Nasdaq Composite Index, increasing from 18.6% and 38%, respectively, as at the end of 2013.
The increasing heft of tech companies in equity indexes represents both the rising number of large companies represented in the sector, and their success in building new businesses, or disrupting traditional ones.
“The direction of technology will be one of the key drivers of how strong equity markets can be over the next 24 months,” Alistair Barker, head of portfolio construction at AustralianSuper, told AsianInvestor in August.
The success of tech companies in recent years has had a disproportionate effect on the performance of stock indexes. In the first half of 2018, for example, the S&P 500 gained 2.65%, with technology stocks alone gaining 2.6% and accounting for 98% of S&P 500 total returns, according to research from Bank of America Merrill Lynch.
The same research showed that outside of the Faangs stocks, the rest of the S&P 500 index actually had a negative return in that time period.
Essentially, US and international stock indexes have increasingly relied on the continued good performance of a small set of tech companies to propel overall gains.
The tech rally and broader equity rise as a whole this year has also largely been propelled by momentum, Olivier d’Assier, head of applied research for Asia-Pacific at Axioma, said. But momentum as a performance driver is inherently fragile, and can quickly reverse when people change their minds.
“People have been loading on momentum [as a performance factor], and this is one factor that hurts when it turns around, and it’s very expensive to get out of. That’s what has been happening [in early October].”
Investor complacency also played a role. As with many stock rallies, fund managers were likely aware of the risks of staying long but ignored them as long as the tech stocks did well, noted Eoin Murray, head of investment at Hermes Investment Management. “It is very tempting to see these stocks in isolation; it’s difficult to bet against them,” he said last month.
With market momentum looking as if it’s entering a downwards trajectory, further stock market drops look likely. Tech stocks could be at the forefront. Guillermo Felices, head of research and strategy for the multi-asset, quantitative and solutions team at BNP Paribas Asset Management, predicted that the Nasdaq could ultimately drop by 10% over the next three months. Murray said the fall could be even higher.
For AustraliaSuper, further market drops would be a concern, given that it is increasing its allocation to international equities from 31.1% to 34% in 2018 in its Balanced Fund.
“Given the size of the market that tech stocks now occupy, it’s a reasonably direct impact,” Barker said. “We’ve been on a trend of reducing our holdings in Australia and shifting more assets offshore, and that had a consequence of increasing our exposure to global technology companies in developed and emerging markets.”
However, as of August, AustralianSuper had taken no actions to minimise risk in the sector, he added. The superannuation fund did not respond to queries on whether it had made any adjustments due to the recent dip in the market.
The market drop is an investment concern and the market will likely need more time to recover and normalise, added Jang Dong-hun, chief investment officer for Korea’s Public Officials Benefit Association (Poba).
The pension fund reduced its exposure to overseas equities, including US equities, from about 6.6% of its portfolio at the end of last year to its current allocation of 3.8%, though this was also driven by its absolute return objectives.
“We have lowered overseas equity exposure because we needed to reduce volatility to achieve absolute returns, not just because of tech bubble or a grim outlook for those tech stocks,” Jang told AsianInvestor in September.
This is part of a longer feature on the concerns surrounding technology stocks in the October/November issue of AsianInvestor magazine. Some of the market data in the story has been updated.