FAGMA: The Five Great American Tech Titans
The S&P 500/SPX’s (SP500) top 5 holdings are tech titans: Apple (AAPL), Microsoft (MSFT), Alphabet (GOOG) (GOOGL), Amazon (AMZN), and Facebook (FB). Remarkably, these 5 juggernauts have a combined market value of roughly $5.5 trillion , and account for nearly 20% of the S&P 500’s entire weighted index.
In fact, technology companies and financials alone make up around 45% of the SPX’s weight, and 60% if healthcare companies are included. Therefore, the SPX, Nasdaq 100 (QQQ), and many other indexes as well as stocks in general are heavily dependent on the performance of just a few sectors.
Now, there are some companies that are overpriced, and some that are likely substantially undervalued. Some sector and specific companies seem reasonably valued, cheap even in certain instances.
Additionally, the Fed is doing a good job in maintaining a proactive stance, macro indicators remain robust, fears over the Coronavirus may be overblown, and overall valuations appear reasonable in key sectors and many market leading companies.
Therefore, barring a substantial global slowdown, and despite the potential for a temporary pullback or a correction, the S&P 500 and stocks in general should continue to move higher throughout 2020 and into 2021.
The SPX Just Went Through a Healthy Pullback
After a brief pullback in SPX as well as in other major indexes, stocks have rebounded sharply and are once again trading at or near new all-time highs.
The S&P 500
The SPX has appreciated by about 5.5% since its recent successful test of the 3,200-support level. The chart looks mildly overextended but that does not mean that the march higher won’t continue. In fact, if a non-transitory global slowdown can be avoided, the SPX could move substantially higher from into year-end.
The Nasdaq 100
The Nasdaq 100 has surged by nearly 8% in recent weeks after its pullback. Now, from a technical standpoint QQQ appears overextended here. The RSI is above 70, the chart looks somewhat vertical, and let’s not forget that this tech heavy ETF is up by nearly 40% over the past year.
Nevertheless, given the current economic atmosphere and market dynamics, QQQ is likely to consolidate or go through a mild pullback over the next several weeks before heading higher into Q2 and H2 2020.
Don’t Fight the Fed and Don’t Fight the “Tape”
While some tech titans and other major companies in the S&P 500 may appear overbought right now, in general the market seems to want to go higher here. The market perceives that the Fed is taking and will continue to implement preventive measures that could enable the U.S. to delay a recession for some time.
In fact, recent economic indicators and other elements suggest that the chance of a recession materializing within the next 12-months is extremely slim. Therefore, despite the possibility of a short-term pullback, the “Tape” is likely to continue its upward trajectory, leading to multiple expansions, higher valuations, and higher stock prices.
Fed Support Critical for Markets
The Banks may not want any more Fed lending, yet the Federal Reserve System continues to flood the bank and lending market with $10 of billions of dollars through its REPO program. At the same time Chair Powell claims he’s not supporting equity markets. Nevertheless, he does discuss the Coronavirus and its plausible effects on future growth projections. This implies that if a transitory slowdown does materialize due to the Coronavirus, the Fed will likely step in and act with further rate cuts and possibly other forms of easing as well.
If we look at market expectations for the July 29th’s meeting, we see that the market is already leaning towards at least one rate cut. Right now, the CME Group’s Fed watch tool is implying that there is about a 45% probability that rates will remain where they are now, vs. a 55% chance that the funds rate will be at least a quarter point lower on July 29th.
Macro Indicators Remain Robust
Manufacturing appears to be coming out of its recessionary slump as the latest ISM manufacturing PMI came in at 50.9, beating the 48.5 estimate by a wide margin. The ISM non-manufacturing PMI also beat estimates, coming in at 55.5 vs. the expected 55 figure, illustrating that the services sector of the U.S. economy is functioning quite well.
Job numbers were a blowout, as the U.S. economy created 225K new jobs in January, crushing the anticipated 160K number by over 40%. Hourly earnings, and even the participation rate also ticked up in the month, coming in better than analysts were anticipating.
Recent economic indicators suggest that the U.S. economy is essentially firing on all cylinders and it is unlikely that a recession will materialize within the next 12-months unless a substantial global slowdown arises.
The Coronavirus is a significant phenomenon that carries an element of uncertainty and should not be overlooked or underestimated. Already there have been approximately 60,000 confirmed cases and over 1,300 deaths from the disease. The economic consequences are difficult to assess, but it is likely that the Chinese economy may slow down more than anticipated due to the virus. Moreover, due to close ties between the U.S. and the Chinese economy unintended ripples could put a transitory dent in the U.S.’s growth as well.
Additionally, revenues and profits of many U.S. multinational companies could be impacted negatively due to the virus and its rampage in areas of China. Nevertheless, I view this as temporary event and economic activity will likely bounce back in Q2 as well as into the second half of 2020. Therefore, if we do get a selloff in U.S. equities due to fears over the Coronavirus, it will likely present a compelling opportunity to accumulate shares at lower levels.
America’s Great Tech Titans Fueling The S&P 500 Rally
What separates the U.S. from any other market in the world?
The U.S. (S&P 500) is the market with the 5 tech titans of America and numerous other high-tech companies that are likely to continue to dominate market share worldwide. Moreover, companies such as Tesla (TSLA), Netflix (NFLX), Nvidia (NVDA), and many others are likely to capture substantial new market share in the future.
Not All FANGs are Created Equal
While I am used to using the FANG acronym, I am primarily discussing the 5 tech titans of America now, as they are more important for the SPX and markets in general in my view. Facebook, Apple, Google (Alphabet), Microsoft, and Amazon. We can adopt a new acronym, and call these companies FAGMA, the Five Great Tech Titans of America. The bottom line is that the U.S. is the top tech market in the developed world because it provides substantial growth potential coupled with reasonable value.
For instance, Facebook trades at only 19 times 2021 consensus EPS estimates. Now, this is a company that is projected to increase revenues by roughly 20% this year as well as in 2021. Revenue growth will likely decline into the high to mid-teens after 2021. Nevertheless, this implies that the company’s EPS can continue to grow at a double-digit pace for several years, possibly into 2025 and beyond. Based on these elements, Facebook is not particularly expensive at current levels. In fact, if we take a longer-term perspective, the company appears rather cheap and is a long-term buy here in my view.
FB 1-Year Chart
At 24 times consensus 2021 EPS projections, Alphabet is not as cheap as Facebook. Yet, considering that Alphabet is essentially a monopoly in its core search segment (controlling roughly 93% of search market), and that it is projected to increase revenues by roughly 17% this year and the next, the stock is still a buy here.
GOOG 1-Year Chart
Microsoft is a bit more expensive, as it trades at roughly 29 times 2021 consensus EPS estimates. Yes, it is also essentially a monopoly in its “desktop” OS business with about a 78% market share worldwide. The company is also projected to grow revenues by about 12-13% this year and the next. Moreover, the company has illustrated that it is extremely capable of sustaining double digit revenue growth and is likely to continue to do so going into 2022-2023.
I like the stable growth that Microsoft provides, as well as the dominant position the company has obtained not only in its OS business, but in other areas as well. Nevertheless, with a forward P/E ratio of nearly 30, MSFT is a hold here in my view and could use a correction to bring its valuation down to a more attractive level.
MSFT 1-Year Chart
We can see that MSFT has gotten bid up quite aggressively after the pullback to around $160 support. The chart looks overbought and I would like to see some more downside, at least to around the $175 level before adding more shares.
Apple is an amazing company that produces some of the highest quality products in the world, has an incredible ecosystem, and is one of the best managed money-making machines I have ever encountered. However, unlike the other tech titans of the S&P 500, Apple is more cyclical, consumer sensitive, and is not a “true monopoly”. The company trades at around 20 times next year’s projected EPS estimates, and is expected to grow revenues by roughly 8-10% this year and the next.
Going by these estimates, Apple is also relatively inexpensive. However, due to the nature of Apple’s more cyclical type business, the impact of a possible slowdown in the global economy would reflect poorly on the company’s earnings and its share price.
Therefore, the company could be fairly valued here, and the stock could even use a correction after the incredible run up we’ve seen in Apple shares over the past year or so. Thus, Apple is a hold for me here, but I would pick up more shares sub $300 – $270.
AAPL 1-Year Chart
AAPL has appreciated aggressively over the past year, by around 90%. This is somewhat unprecedented for a company in Apple’s position. Nevertheless, the stock is now priced far more accurately than when it was trading at 12-15 EPS a year or so ago. Although I would like to pick up shares at a lower level, it appears that Apple may consolidate and could potentially continue to move higher throughout the year.
Amazon is the tech titan that is not cheap. The company currently trades at about 53 times next year’s EPS estimates, and is projected to grow revenues at about 17-19% this year and the next. While I like Amazon as a company, and it will likely continue to provide double digit revenue growth into 2022 and well beyond, I would not buy the stock here. It is a hold in my view, and I own Alibaba (BABA) instead, which trades at just 25 times next year’s estimates. The businesses are extremely similar, yet Alibaba is essentially twice as cheap, and has more long-term growth potential than Amazon in my view.
AMZN 1-Year Chart
After an uneventful year, Amazon recently surged by about 20% due to substantially better than expected earnings. Nevertheless, the stock looks extremely overbought on a short-term basis and I would prefer to wait for a lower entry point before committing any capital to this stock.
If we look at valuations in general, we see that forward estimates suggest that stocks are not terribly expensive right now. The forward P/E ratio for the SPX is only around 19. Given that roughly 30% of the index is comprised of technology names, the S&P 500 likely has room for multiple expansion.
The Nasdaq 100 is also relatively inexpensive with a forward P/E of only 24. Thus, we can probably expect to see higher multiples coupled with higher stock prices going forward provided a significant economic downturn can be avoided.
Bottom Line: Stocks Have More Upside Going Forward
The S&P 500 and other major indexes are being led higher by the five great American tech titans as well as by other technology names in general. America’s tech industry provides international investors with a unique opportunity to invest in high quality, monopoly type companies that provide substantial growth opportunities at reasonable valuations. Therefore, inflows into the U.S. tech sector and into the S&P 500 are likely to continue.
Moreover, the Fed’s preemptive stance is a constructive backstop for markets, economic indicators in the U.S. remain strong, and the Coronavirus will likely have a transitory and limited effect on global economic growth. Although a correction could occur sometime in Q1/early Q2, the S&P 500 and most U.S. stocks should rebound and end the year higher. The unlikelihood of a near-term recession should enable multiples to expand further throughout 2020. My year-end price target range for the S&P 500 is 3,500 – 3,800, roughly 13% above current levels, if stocks can hit the upper-end range of my estimate figures.
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Disclosure: I am/we are long FB, GOOG, BABA, NFLX, MSFT, AND OTHER STOCKS IN THE S&P 500. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article expresses solely my opinions, is produced for informational purposes only and is not a recommendation to buy or sell any securities. Please always conduct your own research before making any investment decisions.