The analysts said that momentum and growth as market factors are elevated and the tech names are appealing because investors may be looking for opportunities that are not dependent on policy changes in Washington.
UBS also commented on the FAAMG group of big tech stocks Friday. Julian Emanuel, equity and derivatives analyst, still likes tech but says they could be vulnerable in the near term as investors rotate to other groups.
“That could be a short-term headwind given the outperformance. But the long-term earnings growth story remains intact,” he said. Emanuel noted there were four times when a handful of tech names became so powerful. Twice, it ended badly—after 1999 and 2007. But they also were leaders in 1993 and 2005.
He said it’s notable that on the previous occasions, Microsoft fell 62.8 percent after the 2000 bubble and was down 45.4 in the financial crisis in 2008. “Such declines now appear as blips on a long-term chart,” Emanuel noted.
The FAAMG group does break some historic trends. Goldman Sachs says the volatility in the FAAMG bloc is lower than not only the S&P 500, but the staples sector and utilities. The group continues to be closely tied to tech and discretionary stocks, but it has also started trading more with the other sectors following the U.S. election and its correlation to staples and utilities is at a five-year high.
“Steady sales growth, rising cash balances and limited market shocks have dampened realized volatility to the point that they now look more like consumer staples than tech stocks. If FAAMG was its own sector it would screen with the lowest realized volatility,” the Goldman analysts wrote.
But they also noted that investors are using the group as a bond proxy. “Since November, correlation has turned negative suggesting that higher bond yields, typically associated with stronger growth, will weigh on stocks while falling bond yields are a good thing,” they said, adding it runs counter to history.
While they may be loved, today’s tech darlings aren’t without potential flaws.
“We believe low realized volatility can potentially lead people to underestimate the risks inherent in these businesses including cyclical exposure, potential regulations regarding online activity or antitrust concerns or disruption risk as they encroach into each other’s businesses,” the Goldman analysts noted.
Momentum in the group “has built a valuation air pocket” and is “creating cause for pause,” they wrote.
“The fear is that if fundamental events cause volatility to rise, these same passive vehicles will sell and exacerbate downside volatility,” they added. Goldman points to a warning in the options markets, which is pricing in more volatility for the companies when looking at options three months out, and prices suggest the FAAMG stocks would be more volatile than the average stock in 6 of 9 major sectors, including tech.
Free cash flow for FAAMG has plateaued after doubling between 2006 and 2016, and at the same time the group has increased capital expenditures to 17 percent while cash flow from operations grew at less than 10 percent. Cash levels have also plateaued as a percent of market cap.