Industry Spotlight

Amazon and Facebook share prices soar in tech surge; but is a pullback due?

Earnings season is in full swing and tech companies such as Facebook [FB], Microsoft [MSFT] and Amazon's [AMZN] share prices leading the pack with some of the strongest showings. 

On 26 July, for instance, two of the largest gainers of the day among US blue-chips were Google parent Alphabet [GOOGL] and Twitter [TWTR], whose share prices rose as much as 12% and 11% respectively, after reporting better-than-expected second quarter results.

The duo’s corporate earnings beat propelled US indices to record highs, as the S&P 500 rose 0.74% to $3,025.86, bringing it closer to beating its biggest year-to-date (YTD) return since 1997, while the Dow Jones and Nasdaq climbed 0.19% to $27,192.45 and 1.11% to $8,330.21 respectively. Both the Dow and Nasdaq are close to achieving their biggest YTD increases since 2013 and 2003, respectively.  

Technology is by far the best performing sector in the US index, following the rise of the Technology Select Sector SPDR Fund – an exchange traded fund that represents the technology sector within the S&P 500 – to an all-time-high of $82.75 on 24 July, boosted by a rebound in chipmaker stocks.

 

What’s driving the market? 

Market pressures from a slowing global economy – the US economy slowed to an annualised growth rate of 2.1% in Q2 –, a stronger US dollar, and trade tensions all continue to weigh heavily on stock markets, pushing investors into the arms of big tech. 

Indeed, Silicon Valley companies have been known to be reliable in producing significant returns against volatile backdrops, with Microsoft, Apple [AAPL], Amazon and Facebook accounting for 19% of the S&P 500’s total return this year, according to The Wall Street Journal.    

19%

MSFT, AAPL, AMZN and FB's combined contribution to the S&P 500's TR this year

Apple, Amazon, Facebook and Google all appear to be resilient so far in the face of growing headwinds, even following the Department of Justice’s sweeping antitrust probe looking into the behaviour of large tech organisations, announced last week. 

After Facebook announced better-than-expected earnings and revenue for Q2, a $5bn bill from the Federal Trade Commission was a minor scrape at best, particularly when compared to the company’s $13.87bn in cash. 

Many analysts recognise that tech stocks have consistently delivered high rates of returns for traders no matter where the general economy goes, as sentiment is usually based on their association with growth trends such as cloud computing and artificial intelligence.  

“If you don’t own a core holding in some of the leaders, you might be missing out,” Allianz Global Investors’ investment strategist Mona Mahajan, told The Wall Street Journal. “Those few names are probably benefiting disproportionately because they have real growth stories behind them.”

 

Is a pullback in store? 

Tech stocks in general, particularly the FAANG group (Facebook, Apple, Amazon, Netflix [NFLX] and Google), have become known for their staggeringly high valuations compared to the S&P 500 as a whole.

 

  Amazon Facebook Apple
Market cap $936.51bn $562.32bn $956.49bn
P/E ratio (TTM) 78.55 33.33 17.49
EPS (TTM) 24.10 5.91 11.89

Amazon, Facebook and Apple share price vitals, Yahoo finance, 30 July 2019

 

However, such a high-growth industry comes with drawbacks, as many of these stocks, including Microsoft and Apple, which are valued at a massive $1.07tn and $956bn respectively, are considered volatile. A slight pullback could send them tumbling. 

For example, Apple’s beta sits at 1.24, suggesting it is more volatile than the wider market. Its price-to-sales ratio of 3.7 and price-to-book figure of 9.13 also exceed the industry averages of 1.33 and 1.32, respectively.

For Goldman Sachs’ chief equity strategist David Kostin, high valuations coupled with the threat of increasing regulation is the recipe for a pullback, as he advised clients to limit their exposure to companies that could be affected by antitrust lawsuits. 

“Rising market concentration and the political landscape suggest that regulatory risk will persist and could eventually weigh on company fundamentals,” Kostin wrote in a note to clients in June. “The valuation premium for growth is elevated today relative to history; Software in particular now carries the highest multiples since the tech bubble.”

The S&P 500’s forward P/E of 17.1 is well above the five-year average of 16.5 and 10-year average of 14.8, indicating a growing risk for investors. The tech sector as a whole is also trading 21.4 times forward earnings – the highest level in 15 years according to AB Berntein’s Toni Sacconaghi. 

As today’s tech stock’s sky-high valuations continue to worry analysts amid market conditions bearing similarities to the carnage endured during the dot-com bubble, is history in danger of repeating itself?

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