How to prepare for a tech bubble
15:37, 10 January 2022
If you are a FAANGM investor, you would be forgiven for holding your head up high. For years, these companies have consistently offered investors a good return.
For those not in the know, FAANGM stands for Facebook, Amazon, Apple, Netflix, Google (Alphabet) and Microsoft. These juggernauts are popular, fast-growing and outperforming. In recent years, there has been little, if anything, to worry about for investors in these stocks.
Some may argue that these companies are too big to fail. However, if you are overexposed to FAANGM, there is a good chance you could lose a large chunk of your investment savings if things go wrong.
Too much tech?
FAANGM now makes up almost a quarter (24%) of the US market. While this may not necessarily be a bad thing, some analysts are starting to be concerned and are warning that an overconcentration in these stocks could be a risk.
If you are reading this as an investor based in the UK or elsewhere, you may not be overly concerned. But you could still be vulnerable, particularly if you invest in global funds.
“Tech makes up a quarter of the MSCI World Index. If you are investing in a broad stock market index, that means that a quarter of it is invested in tech,” noted Laith Khalaf, head of investment analysis at UK investment platform AJ Bell.
You may even be exposed to tech stocks indirectly through other investments. For example, just at the end of last year, Warren Buffett grew Berkshire Hathaway’s Apple stake to 50% of its entire equity portfolio.
Unrealistic valuations?
Companies like Apple have seen great success and their valuations have ballooned.
But some say this is a problem. Analyst John Owens at Morningstar, for instance, has suggested that companies like Apple and Netflix are overvalued, trading at 22% and 128% premiums, respectively.
In an October 2021 report compiled with Morningstar colleague Tyler Dann, he said: “We would also note that Amazon and Netflix trade for roughly 50 times the Bloomberg consensus earnings estimates for the current year. So, the valuations on some of these stocks are worrisome”.
Impact of inflation
The latest minutes from the last meeting of the US Federal Reserve hint that interest rates could go higher and do so faster than expected in 2022. This could mean an end to the fantastic rates of growth enjoyed by FAANGM investors.
“The last decade has been characterised by low inflation, low growth and low interest rates. In that environment, long-duration assets, bonds and growth stocks (companies seen as capable of generating increases in sales, profits and cash flow almost whatever the weather) have been highly prized and performed strongly,” AJ Bell investment director Russ Mould said. “If that environment is now changing, it would be logical to expect those assets to do less well. In theory, high inflation, faster (nominal) growth and higher interest rates would persuade investors to look at short-duration assets, such as commodities, cyclicals and ‘value’ stocks”.
Mould warns that if inflation means there is plenty of growth around now, then there is no need to pay high premium valuations for disruptors that feature so heavily in, for example, the ARK Innovation ETF, the Nasdaq Composite and the Nasdaq 100 indices.
“This would again lead investors toward cyclical stocks like industrials, banks, oils and miners that have underperformed for years and trade on much lower valuations as a result, and lead them away from tech and biotech stocks, which have outperformed and are highly valued as a result,” Mould added.
Impact of regulation
Regulation is another potential hurdle for FAANGM investors. There is concern in most countries that these businesses have too much of a monopoly in their sectors.
Margrethe Vestager, the European Commissioner for Competition, has shown an appetite for clamping down on the likes of Google, for example. She was behind fines handed down to Apple for tax evasion in 2016 and to Google for antitrust violations.
However, Khalaf believes that regulators may not want to pressure FAANGM companies too much.
“There has been blowback on bigger companies in terms of monopolies and anti-competitive behaviour but that has been rumbling on for a while and has not dented their performance just yet,” Khalaf said. “To date it has kind of been like a dog that has not barked. These companies are now critical to how we behave, how we live and how we conduct business. It is difficult for global regulators to come down too heavily”.
Taking action
So, what should you do if you still have concerns that inflation, regulatory pressure and overpriced valuations will result in a crash?
Khalaf advised investors to take an active approach to their portfolios, particularly if they have a lot of money invested in tech, global and US funds.
“Diversify into the UK, Europe, Japan and emerging markets. Look at regional equity weightings and have a look at some areas where you do not have exposure,” said Khalaf. “If you have active funds ... find out which ones have tech exposure. Take the profits and invest in those who are not so much steered at tech stocks”.
Read more: Top 5 tech stocks to watch: will the boom continue?
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