Heavy-hitting tech stocks have marched investors all the way to the top of a very big hill. Are they about to lead them back down again?
For years, those of a more nervous disposition have been concerned by the outsized role Big Tech plays in US stock markets. Together, the 10 biggest stocks, mostly tech-flavoured, account for about a third of the entire market capitalisation of the S&P 500 index. That is far above the concentration observed in the previous tech bubble peak of 2000.
So, the bear case goes, if they hit a bump, they could topple the rest of the market with them. Even the most optimistic of fund managers have had this in the back of their minds since well before the pandemic struck.
It has not mattered. Until now.
Meta — known as Facebook before chief executive Mark Zuckerberg decided very normal humans would enjoy communing with their very normal human friends in the form of 1990s-style avatars — this week delivered a humdinger of a warning on its outlook, sending its stock, and the broader market, reeling.
More than $230bn vanished from the company’s market capitalisation when shares fell 26 per cent after Zuckerberg acknowledged he was feeling the pinch from the competition. The value destruction is roughly equivalent to the entire size of Intel, or more than one McDonald’s, and was enough to produce the worst day for the overall S&P 500 index of US stocks in more than a year. It is the biggest drop in absolute terms in a US company’s market value ever. You get the idea.
Pretty much all sensible investors knew 2022 would be a rougher ride than 2021, now that big central banks are preparing to withdraw the support they pumped into the financial system when Covid-19 struck. But few saw this coming.
Move over, the “spec tech wreck” from January, when the largely unprofitable end of the tech sector took a drubbing. That wobble was just starting to heal. Now we have a “Zuck shock” biting into what has been the bedrock of the market.
Size, of course, matters in this respect. “When these companies have market caps of $300bn to $1tn and they fall 25 per cent, this causes a lot of pain,” said David Older, head of equities at Carmignac.
The backdrop also matters. Since December, it has been very clear that the US Federal Reserve has changed its mind. It really does intend to jack up interest rates to douse down an uncomfortable rise in inflation, and it will not mechanically or quickly step in if markets puke in response. This severely compromises the froth that has built up in financial markets.
Much of the gains in tech stocks have not just been down to the profitability of the sector but also the fruit of widespread speculation and the vast flows of money into stock markets. This has driven up valuation multiples for companies.
That means a lot of fund managers who think they have made shrewd bets on the future of the global economy are actually, at least in part, momentum riders like everyone else.
“A lot of what we have seen in terms of the rally in tech stocks is multiples expansion,” said Older. “Nobody wants to say it because everybody thinks they are a genius, including me. But it is.”
Broad risks overhanging the sector include regulatory intervention on antitrust or privacy concerns. But, crucially, this week has not been indiscriminately horrible for prominent US tech stocks.
PayPal and Spotify have suffered, as did Netflix earlier. But Amazon shares rocketed after the company showed it still had the power to command higher prices from customers for its Prime services. Shares in social media group Snap tanked 24 per cent midweek but bounced back by almost half towards the end.
“The real problem for Meta was their valuation,” said Ian Harnett at Absolute Strategy Research. “While Fed rates were low and stable, then their historic earnings per share growth was enough to justify an elevated multiple. But as we see the threat of higher rates coming through, it exposes highly valued companies to any kind of earnings miss.”
That is why the Zuck shock is a cautionary tale. Given the size of the big companies, if the retreating tide of liquidity exposes even one of them, it will hurt a lot of investors.
Tatjana Puhan, deputy chief investment officer at Tobam, the $10bn French quantitative asset manager, has fretted over the role of what she calls “big elephant” stocks for some time.
She pointed out that concentration is not exclusively a US phenomenon. In emerging markets, one need only look at the broader market shock stemming from the Chinese tech crackdown last year to see that when big elephants fall over, they make a mess.
“Investors today have a large part of their portfolios either in exchange traded funds that track capitalisation-weighted indices or something very close to them,” she said.
“A lot of investors today have accumulated a substantial risk concentration in their portfolios because of this. Even if you invest broadly in the market, you think you are diversified, and you are not. You are loaded up on a particular type of risk.”
Good luck out there.