Rallying Markets Led by Tech Giants: Another Bubble?
The winners of the ongoing health crisis are few of many. The FAANG (Facebook, Amazon, Apple, Netflix, and Google) stocks have, for now, held much of the strength in the rallying of markets. A future discounting mechanism by nature, capital markets show continued positive forward momentum. However, a small number of Wall Street investors remain skeptical of this rally riding on cheap money as governments pump capital into their economies to try and keep afloat.
Massive companies have filed for bankruptcy (including rental car company Hertz in late May), and only a month ago oil prices were negative. The ongoing global health crisis has inflicted extensive damage on the US economy, with record high unemployment claims rising by more than one million for 17 weeks straight. Yet, major indexes continue to climb.
Stocks such as Amazon and Apple, some of the largest US tech companies, hit record highs in the last few days, pushed upward by the demand for safe-haven stocks in an uncertain world. Investors have moved into higher-risk asset classes as a result of holding lower cash levels in their portfolios given this rapid recovery in prices. Hedge funds have enlarged their exposure to stocks while investors have been overweight on equities for the first time in six months.
This increased appetite for risk is in large part attributable to data suggesting the state of the US economy does not heavily influence Tech earnings.
The COVID outbreak has demonstrated, for the first time in many years, that other wealthy industrialized countries have stronger economies and government than the US.
Ritholtz, former chief executive and director of equity at FusionIQ, writes for Bloomberg Opinion, “Nations such as Japan, South Korea and Germany not only have managed to contain the pandemic, but their economies are well ahead of the U.S.’s into their re-openings”.
Foreign markets provide growing revenues for mammoth American tech companies such as Netflix, which has been looking to develop abroad as growth slows within the US due to a nearly tapped-out consumer market. Analysts expect that much of Netflix’s future growth will come from international markets. The lockdowns imposed in the last couple of months have only fueled the expansion of the movie streaming giant. FAANG peers such as Apple and Facebook also generate large portions of their income outside of the US. Loved by legendary investors such as Warren Buffett, Apple generated over 55% of its revenue from countries other than the US in 2019. Facebook’s foreign revenues lagged very slightly at 54.4% and Alphabet (Google’s parent company) at 53.8%. Although Facebook generates more than half of its revenue domestically, it now has more users in India than in the US. Alphabet has also generated revenues faster across both Asia and Latin America than it did throughout the US.
Amazon is the only exception amongst the FAANG generating most of its income stream within the US given strong international competition from the likes of Alibaba. Both e-commerce tech firms dominate the countries they were founded in.
The global movement towards digitalization has further raised the weight that major tech companies have on indexes compared to other struggling industries. For a handful of years now, the FAANGs, with the addition of Microsoft, have exerted an outsized influence on US capital markets, making up two-thirds of the S&P 500 gains. The outsized performance of Tech in comparison to other industries such as financials has only increased its influence. The latest rally is an example of the power that Big Tech has on driving American capital markets. Tech is winning in this environment.
However, there is growing worry that valuations are not what they seem as blind optimism may be leading to the overvaluation of firms. Fund managers have grown worrisome of the trendy “tech bet” as investors plunge into American tech stocks. Record highs have been hit by leading tech companies seemingly unscathed by the global pandemic.
The volatile returns on the Tesla stock in the last five days leave some wondering: what is the real outlook for the firm? Investing in Tesla requires taking a large leap of faith for the car manufacturer that has yet to prove consistent profitability for cars questionable quality, an issue highlighted over the recent months.
Markets have been discounting in view of a bright outlook at a nearly pre-pandemic economic recovery. Until now, the US has done a poor job relative to other countries around the world at containing the virus. On Friday July 17, the US reported 77,200 new coronavirus cases, raising the seven-day average to more than 65,400 new daily cases, whereas Germany has reported a seven-day average of 324 total new reported daily cases. A potential payroll tax cut on the next relief bill by the Trump administration is likely to push forward a market already driven by policy. Many companies, as a result, are priced higher than their fair value.
The danger of a second wave of infections is eminent, evidenced by several US states reversing their reopening plans as a result of Covid-19 cases rising. A resurgence of the virus is currently the biggest threat to US equity performance. Last month, a considerable amount of fund managers believed a V-shaped recovery the most likely outcome. A U-shaped recovery now seems like the most supported outlook on Wall Street.
As market optimism grows increasingly fragile and neurotic, institutional investors prepare themselves for a reversal in the latest gains. Rising spikes of the virus continue to delay and roll back the reopening of the economy desperately needed by companies.
Tech firms amass sky-high valuations fueled by injections of capital that lead to an overestimation of the value of the product and/or service they provide. For now, the winners are clear, but how long will they keep on winning?