The mega-cap internet names have taken a beating in the last few weeks as a series of events have created catalysts for some long overdue profit taking. First and foremost, this is healthy price action. I am concerned about how many investors have never seen a proper pullback leave alone a bear market. They are a necessary and healthy part of market development. The specific stories that have either led or magnified this move have been the Cambridge Analytica scandal at Facebook, the Trump tweets about unfair competition from Amazon and the news of an auto-pilot fatality for Tesla. Key high growth names have seen their first proper set-back for some time.
Mega-cap and popular technology companies – pull back from 2018 highs (April 2nd 2018)
While most of these names are now down slightly on the year, Netflix is still up 46% year-to-date and Amazon +17% - still great performance relative to the major indices.
The bigger question being asked now is whether this is the start of a secular rotation away from growth and mega-cap technology. We don’t think so for a number of reasons. While the biggest technology companies occupy all the top five spots in the S&P market cap list, their combined market cap equates to a below historical average of 8% of the index make-up. The following chart from MSCI illustrates this point well. The average weight of the top five was just above 8% and this is well below the historical highs of almost 18%.
In fact, the current level of concentration amongst mega cap is far from atypical when compared to the era of the late seventies and early eighties. In this period it was the last-gen innovators that led the list with significantly more concentration than today. Here is a list of the top five in each period again from MSCI.
In the 1976 period, IBM was over two times the weight that Apple is today. Who would believe that Eastman Kodak had a bigger share of the index in 1976 than Facebook has today? The point here is that the size of today’s market leaders is not out of line with history, far from it and so I do not think this is a reason for concern. There will be many twists and turns in the debate about data and privacy but we think the resulting path will be iterative and not revolutionary – Cambridge Analytica highlights something that has been in the minds of investors and throughout society for some time. This is the perhaps the tipping point for bringing it to the fore and into a more open debate.
Another important feature of the most sensitive data related businesses today, Facebook and Google in particular, is that they are not expensive. Following the pull-back in the market, Facebook trades on just 17.7x 2019 earnings or 9.6x EV/EBITDA (Source: Bloomberg). That is very cheap for a growth company. Google trades on 20.7x 2019 EPS and 10x EV/EBITDA (Source: Bloomberg), again inexpensive in my view. Once the initial storm has passed, these two companies will be left looking very attractive however, with GDPR (General Data Protection Regulation) coming down the pipe in May in Europe, there is no rush to buy for the moment. Market jitters are more likely to impact the higher valued names in any further selling and I believe this would likely include Amazon, Tesla and Netflix.
The other factor to consider in looking at the possible implications for growth stocks in a rotation or dash for safety is perceived value. I am well aware of the risks for underperformance from a safety first approach as we saw in 2015/6. In 2016, most of the technology index performance came from dividend yielding shares – a growth first bias made this a tough environment. However, there is a very different backdrop in today’s market for yield shares. Below is the chart of the dividend yield of the S&P 500 and the yield of the US 2 year bond. For the first time since the great financial crisis, short term bond yields exceed equity dividend yields. This makes the case for dividend payers less obvious and probably explains why in the sell-off to date, incumbent, cash generative and dividend paying names have fallen no less than their growth counter parts. Apple, Microsoft, Intel and Cisco have fallen 9-11% from their highs while IBM and Oracle have matched the growth falls with 14-15% sell-offs.
Look also at the SaaS (Software-as-a-Service) companies that in previous market corrections have fallen with a beta of two or three times the sector. They have fallen no more than any other names again reflecting the much better balance of risk between growth and value at the moment. In fact, many have fallen less than their mega-cap dividend paying counterparts. Veeva down 8.7% from its 2018 high, Atlassian -13%, ServiveNow -8.5%, Salesforce -10.5%, Adobe -8.2% - this is a very different sell-off from those previous with growth more than holding its own against the perceived safety of value.
US 2 year yield versus S&P 500 dividend yield 2008-2018