How the Stock Market’s Tech Leaders Will Be Ousted

Art by Klaus Kremmerz

What will it take to topple Apple, Amazon, and the other tech titans from their seemingly unassailable perches atop the stock market?

The six sizzling tech stocks, known by the acronym FANMAG, compose roughly one quarter of the S&P 500’s $27.9 trillion valuation. For some time, they’ve been responsible for much of the index’s growth.

But nothing made by mere mortals can last forever, and, in the case of stock market leadership, even a decade. The current situation reminds Robert “Vince” Smith, CIO of the New Mexico State Investment Council, of the dot-com craze of the late 1990s, which came to an ignominious end.

“These stocks were going to the moon, and you couldn’t miss with them,” Smith said. “We see the same dynamic today.” At some juncture, Smith predicted, “there will be a tipping point,” and the fabulous FANMAG stocks will lose their prominence.

Possible factors that could dethrone them include FANMAG price stagnation or dips, a rise of more mundane stocks or disruption by new challengers, and a government crackdown.

Right now, their dominance seems rock-solid. Over the past five years, Facebook, Apple, Netflix, Microsoft, Amazon, and Google parent Alphabet—hence, the acronym FANMAG—have logged scorching advances. Their expansions since 2015 have ranged from Alphabet’s doubling (it logged the smallest increase) to Amazon’s six-fold growth (the largest). The six companies constitute almost two-thirds of the market cap for the Nasdaq 100, which are the leading stocks in the Nasdaq Composite.

What’s more, this sextet has outrun the broad market’s growth since 2015. Using the Nasdaq 100 as a proxy for the tech leaders, they soared past the S&P 500 every year except for 2016. That’s when commodities, particularly oil, were surging, and investors feared that President Donald Trump’s election would hurt tech stocks via his threatened trade war with China.

Starting in 2017, commodities receded amid an oil oversupply and the trade war didn’t harm the tech leaders much at all. FANMAG reclaimed its winning ways.

The Tech-Heavy Nasdaq 100 Has Skunked the Broad-Market Index

From 2015 to October 9, 2020
Nasdaq 100   S&P 500

Source: Morningstar

Indeed, the top five stocks of the S&P 500 are the FANMAG names, except for Netflix, which in market cap terms is the runt of the litter at $237 billion. (Netflix’s price has grown almost as fast as Amazon’s, though, which merits its inclusion in the top tech stocks list.) At the outset of today’s tech romp, the leaders were known by the acronym FAANG, but Microsoft’s prominence made omitting it look foolish, so Wall Street informally added the company to the kick-ass club.

What will hold them back, or downright capsize them, could be one of these things, or a combination:

Price Stasis or Stumbles. Reversion to the mean is a key trait of financial physics. Sometimes go-go stocks need to “grow into their P/Es,” said Brad Kinkelaar, an equity portfolio manager at Barrow, Hanley, Mewhinney & Strauss. At present, FANMAG companies boast solid business positions, strong balance sheets, and great growth prospects, he said. “They’ve changed our lives forever.”

Nonetheless, that doesn’t grant them eternal hegemony. Walmart in the 1990s, for instance, wowed the market as it spread across the US. Its stock hit a peak of $67 in 1999, more than five times what it had been a mere three years before. The 1999 price/earnings (P/E) ratio was a lofty 50. It became the world’s largest retail chain and had the fifth highest market capitalization globally. For the past two decades, the big-box retailer has continued to pile up revenue and earnings, as it pushed into groceries, opened stores overseas, and created a formidable online presence.

But the stock remained stuck around the 1999 level for years, and it only started rising to its current $144 in 2016. Now, Walmart’s P/E is a more reasonable 23—slightly less than that of the S&P 500. And a lot less than what it was at the turn of the century. The chain no longer is at the top of the stock valuation chart.

Market leaders change all the time. According to Gavekal Research, of the top 10 companies by market value in 1990, eight were Japanese, with the only American names being IBM at No. 8 and Exxon Mobil at No. 10. Then Japan’s fortunes faded. By 2010, three US companies were on the list (Exxon in first, with Apple third, and Microsoft fifth), along with two from China, and the rest from Switzerland, the Netherlands, Australia, and Mexico. Note that in 2010, there were just two tech outfits present. This year, the top five are US tech giants.

Sometimes, market leaders can lose their status and regain it, albeit that’s rare. To wit, Microsoft. From its position as the world’s most highly valued company in 2000, it seemed to slide into mediocrity in the first years of the new century. In the aughts, the shares stayed at around $25, as talk spread that it was yesterday’s company amid the rise of search and e-commerce. 

But then Microsoft reinvented itself, moving past its old software orientation and entering cloud computing in a major way. The stock has skyrocketed to $221, with a 38 P/E. Most companies can’t pull off such a transformation—and maybe Microsoft won’t be able to repeat that trick the next time the technology landscape changes.

Competition. What’s called recency bias can skew investors’ thinking. In other words, said Andrew Mies, CIO of 6 Meridian, “they believe that things are never going to change.” But once a vaccine drives away the coronavirus, he said, sectors other than tech will get a chance to shine. Finance, energy, consumer staples, and health care have been poor to so-so performers in the stock market. “Tech will do fine, but the others will do a lot better,” he predicted.

A post-COVID-19 world might well see people embracing aspects of life they’ve neglected out of prudence. “How will Netflix do if everyone wants to go to the movies again?” asked Chris Armbruster, a portfolio manager at Kayne Anderson Rudnick. “And if people want to go to brick-and-mortar stores, what would that mean for Amazon’s orders?”

Value stocks have been laggards for a long time, as the bull market has rolled along. They typically do best in an economic recovery, which may or may not be happening now: The signals are mixed and the pandemic messes up standard forecasting tools. But, eventually, value will return. “Value stocks are coiled like a spring,” ready for whatever catalyst will propel them upward, said Barrow, Hanley’s Kinkelaar.

In fact, there are tentative signs that other, non-tech stocks may be gaining on the FANMAGs. The S&P 500 is cap-weighted, meaning the stocks with the biggest market caps (read: the FANMAGs) count much more than the lesser lights. If you equal-weight the 500, however, a different picture emerges. For the past three months, that kind of index has outpaced the cap-weighted one, 13% to 10%.

And who knows? Maybe today’s hot tech companies will be displaced by tech upstarts. Google, founded in 1998, came from out of nowhere to become the boffo initial public offering event of 2004. “What if Google is disrupted by a different platform?” asked David Polak, equity investment director at Capital Group. It wouldn’t be the first time such a comedown has occurred. The big technology stocks of yesteryear, such as IBM and Xerox, are wisps of their former selves.

What’s more, while inflation is tame today, that may not always be the case. Should the Consumer Price Index (CPI) spurt up, then commodities might return to the fore, argued Mark Travis, CEO of Intrepid Capital.

The difference between tech and commodity-based companies “shows extreme financial imbalances,” he said. Oil companies have been “bludgeoned” lately, he added. Exxon, whose stock price has been cut in half over the past five years, has a comparable market cap to that of Zoom Video, the darling of the stay-at-home era, whose stock is up eightfold over that period (their values: $146 billion and $139 billion, respectively). Meanwhile, over the past four quarters, Exxon has generated $213 billion in revenue, versus Zoom’s $1.3 billion.

Government and Legal Action. Bipartisan suspicion of the large tech players is rife, so, regardless of who the next president is, federal action against the companies is highly likely.

The House Judiciary Committee last week issued a scathing report accusing Big Tech of monopolistic practices and urging that the companies to be broken up. The US Justice Department is mounting antitrust probes of Facebook, Amazon, and Apple, as are the Federal Trade Commission and almost every state attorney general.

Divining how successful these efforts will be is hard. Yet one thing is for sure: The stocks that rule today won’t be on the mountain top in coming years.

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