A Tale of Fandango


I was recently meeting with two of my clients and they asked me how the stock market was doing.  I’ve probably heard this question a thousand times and I was prepared to go into the standard year to date returns and past performance regurgitation but something stopped me.  It hit me, that I and probably most people have no idea what the market even is anymore.

Is it the S&P 500 is it the Dow, is it Nasdaq or what?  I was taught to think of the market as the S&P 500 but that was in a time long, long ago.  It was back in a time where the S&P 500 was composed of stocks from multiple industries, where no one industry dominated and it followed a great set of trading rules.  Well the trading rules haven’t changed and it’s still composed of companies from different industries.  However, we now have dominant representation by technology.  We have seen periods of technological dominance in the past but not to the degree we see today.

Let’s look back at the top 10 companies in the S&P500 in the year 2000.  They were in order,

1)     General Electric

2)     Exxon Mobil

3)     Pfizer

4)     Citicorp

5)     Cisco

6)     Walmart

7)     Microsoft

8)     AIG

9)     Merck

10)  Intel

Taking a look at today’s list shows just how much has changed in such a short time.  The new top 10 are as follows in order.

1)     Apple

2)     Microsoft

3)     Amazon

4)     Facebook

5)     Berkshire Hathaway

6)     JP Morgan

7)     Exon Mobil

8)     Alphabet A-Google

9)     Alphabet C-Google

10)  Johnson and Johnson

If you’ve detected a pattern of technology company dominance you would be correct.  6 of the 10 most valuable companies in the country are now technology companies.  Furthermore, these top 10 represent more than 21% of the total value of the S&P 500.  So, what’s the stock market?  I would say technology is the stock market.

An examination of the Nasdaq reveals something else of interest when we look back at the year 2000.  Remember that was the year where the technology bubble hit its apex and subsequently burst.  Did we have a select few companies dominating back then?  The answer is yes, but to a substantially lesser degree.

Let’s look at the top 10 list of Nasdaq companies in 2000 and see how it has changed.  In 2000 the largest companies were as follows and in order;

1)     Microsoft

2)     Cisco

3)     Intel

4)     Oracle

5)     Sun Micro

6)     Dell

7)     Qualcomm

8)     Yahoo

9)     Applied Materials

10)  Uniphase

Today we see something very different.  The list is now as follows and in order

1)     Apple

2)     Amazon

3)     Microsoft

4)     Facebook

5)     Alphabet C-Google

6)     Alphabet A-Google

7)     Intel

8)     Cisco

9)     Netflix

10)  Comcast

What is of note is that while the top 10 companies in 2000 represented 34.2% of the total Nasdaq, the top 10 today represent 55.7%.

What this shows is that over the last 18 years or so, technology has reached a dominant position in the S&P 500 and within the technology sector, a select few companies have dominated.  So, what is the stock market these days?  It’s not technology as a broad category.  It’s Apple, Microsoft, Amazon, Facebook and Google.

With this as a backdrop which allows us to see the market in finer detail, let’s get to the heart of this tale or the FAANG stocks.  These are 5 stocks that have been characterized with exceptional growth rates and the FAANG stands for Facebook, Apple, Amazon, Netflix and Google.  So 4 of the 5 players are represented by the term FAANG.  What does this mean?  It means that the stock market can now be called the FAANG market.  What can we learn about the FAANG stocks will influence how we invest going forward because our money will follow the FAANG.

Let’s forget the individual characteristics of the 5 FAANG players since everyone has an opinion about their favorite and examine the history of growth companies.  I know that everyone thinks this time will be different and perhaps it will but one fact has been indisputable-growth rates for large successful companies slows down as size increases because the system, in this case the global economy, can’t provide enough capacity to maintain historic growth rates.

The growth cycle of a company isn’t too complicated.  You have a small company, in a small industry, with a small market share.  The industry starts to grow, then grows faster and the small company gains market share within the industry.  Eventually the industry matures and the now large company can’t grow like before.

An examination of the largest FAANG company already shows the slow down with Apple growing at about 4% over the last 3 years yet it’s stock price not reflecting this slow down in growth.  Simply put, investors are willing to pay more and more for less and less.  This is the nature of investor psychology and it won’t be too long before the other FAANG stocks join the Apple bandwagon of reduced growth.

How can this happen when there are so many other companies that represent more potential reward and for less risk?  That is a complicated question but it has happened in the past and will again once the FAANG trend comes to an end.  Investors will forever extrapolate past growth rates and assume they will continue into forever and be willing to pay growth prices for maturing companies.  There is nothing new here.

What is new however is that most investors have no idea that they are so dependent on FAANG since they have their money invested in stock index funds.  The triumph of indexing has told them that stock picking does not work, yet they are by default concentrating their bets like never before.  The way this unwinds should be interesting to see but that is for another tale.

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