The US market can thank its FAANGs
While FAANGs have long basked in the investment spotlight, the digital transformation accelerated by the coronavirus crisis has dramatically amplified the market influence of these tech giants in the US. In fact, the phenomenal run of FAANGs—Facebook, Amazon, Apple, Netflix and Google (i.e., Alphabet Inc.)—has pushed the US market into the black year to date. At the same time, FAANGs have become relatively less risky than the rest of the US market, a pattern we also witnessed in the Info Tech sector.[i]
The increased use of digital products and services since the onset of the crisis has resulted in exceptional results for each FAANG. We constructed a portfolio of FAANG stocks, with each company having the same proportional weight as it did in the STOXX USA 900 index, resulting in a five-stock portfolio with the following average weights since the start of the year: 39% Apple, 29% Amazon, 15% Facebook, 12% Alphabet and 5% Netflix.
Amazon was the best performer among the five tech giants, posting a total return of 63% in 2020. Netflix was the second-best among FAANGs, with a total return of 48.5% over the same period. Facebook posted the smallest return at 12%, but it still substantially outperformed the US market as a whole this year.
As FAANG stocks have soared, their weight in the STOXX USA 900 benchmark also increased and now the five stocks make up close to 14% of the US benchmark (up from 11% at the end of 2019). Apple, Amazon, Facebook and Google have the second, third, fourth and fifth largest weights in the US index, respectively, after Microsoft.
But Amazon, due to its high level of gains, contributed more than either Microsoft or Apple to the positive return of the US index. In fact, Amazon had the highest positive contribution (2%) of the 900 stocks in the index. Although Netflix was the second-best performer among FAANGs, its contribution to the US index return was relatively smaller, as its weight in the index was just one fifth that of Amazon.
Note that 40 companies in the US index recorded much higher returns than Amazon, with Moderna, Tesla and Thor Ind posting year-to-date total returns in excess of 200%. Alas, only three of the 40—Tesla, Nvidia, and Shopify—had higher positive contributions to the US index return than Google, which contributed the least among FAANGs (0.2%), because the other 37 had very small weights in the index.
While FAANGs also suffered during the US market’s tumble in February, the five tech companies have had a much stronger recovery since April. FAANGs posted a cumulative year-to-date return of 33%, while the US market barely turned positive.
The stellar performance of FAANGs pushed the US index into positive territory, contributing 3.75% to the US benchmark return. Without FAANGs, the STOXX USA 900 cumulative year-to-date return as of the end of last week would have been -2.17%, while with FAANGs it was 1.54% as of July 24, 2020.
High-flying names like the FAANGs are typically thought of as being riskier than the overall market, and a portfolio of five stocks in similar business is unlikely to benefit from the diversification of a broad-based index. Indeed, the FAANG portfolio has seen substantially higher risk for most of the past eight years.
Risk spiked for both FAANGs and the US market as a whole in February and, suddenly, US Market risk approached that of the five-stock portfolio, as measured by Axioma’s US short-horizon fundamental model. Between April and June of 2020, the risk figures for FAANGs and the US market as a whole were remarkably similar. In other words, the set of stocks that was twice as volatile as the overall market before the Covid-19 crisis, actually became less risky in the aftermath of the pandemic!
Only in July did the two start to diverge, with FAANGs seeing an uptick in risk, as the US market risk continued to decline. That said, the difference still remains far smaller than the historical average.
The active risk of the FAANG portfolio versus the STOXX USA 900 hovered between 10% and 15% between 2014 and early this year, when it shot back up nearer to its 2012 high. After reaching a peak in the beginning of June, the active risk of the FAANG portfolio decreased slightly, but remained at a relatively high level, suggesting that the tech giants are less like the overall market than they were at the beginning of the year.
Another way to look at this divergence is in how much the stocks contribute to overall risk of the benchmark. FAANGs contribution to benchmark risk was slightly below that of their weight in the STOXX USA 900 index on July 24, 2020, suggesting they were somewhat less risky than the rest of the index.
FAANG stocks have driven the market into positive territory this year, as the gap in the volatility of the two has narrowed. The new wave of coronavirus cases, especially if it is followed by renewed lockdowns, will most probably continue to benefit the tech sectors. However, the scrutiny over the oligopoly achieved by some of these companies could be a deterrent factor, resulting in the requirement of a larger ‘regulatory’ risk-premium for investors choosing to hold them.