Has the market been deFANGed?

Familiar growth names have led during the market’s rise — and its fall. So what may come next?

Investors have been predicting the end of the current bull market for years, but it’s continued to age well. From 2009 through 2017, the total return of the S&P 500 Index was positive every year.1 And even after a volatile autumn, the index was still in the green for 2018 as November came to a close. But there’s one month left to go in the year, and volatility has recently increased among the FANG stocks (Facebook, Amazon, Netflix and Google/Alphabet2). This has led to investor concerns as these stocks have led the market on the upside and the downside. So is this finally the end of the bull market? I believe the recent FANG underperformance has less to do with the companies themselves, and more to do with the overall macro environment. With no clear case for continued underperformance, I expect these companies to recover from the recent selloff.

Five years of outperformance

The current bull market has provided strong returns over an extended period, but it has been the small group of FANG stocks that has captivated investors, achieving great notoriety in the last decade. While the S&P 500 Index has recorded annualized returns of 11.1% over the past five years, the FANG stocks have returned an average of 26.9% per year over this period.3 FANG has traditionally stood for the four companies mentioned above but there are two other stocks (Apple and Microsoft) which I also consider to be market leaders given their size, prominence in the market and strength of returns.

Cracks in the FANG armor

The S&P 500’s high point of 2018 was on Sept. 20, when it recorded a year-to-date return of 11.2%. The average return of the FANG+ stocks for that period was 38.3% (led by Netflix at 90.3% and hurt most by Facebook at -5.9%). Between Sept. 20 and Nov. 30, those gains were pared down. While the S&P 500 lost 5.5%, the average FANG+ stock was down 12.9%. As shown in the chart below, the Nasdaq-100 Index, which overweights the FANG+ stocks compared with the S&P 500, captured more of the FANG+ performance than the broad market.

Source: Bloomberg L.P., data as of Nov. 30, 2018. Market peak is September 20, the highest level for S&P 500 Index in 2018. Past performance is not a guarantee of future results. An investment cannot be made into an index.

Why have the FANG+ stocks corrected?

It’s difficult to pinpoint any company-specific reasons for the recent correction. The blame can likely be shared by concerns around tariffs, tighter monetary policy and a mixed earnings season. Whether the recent downturn will be a short-lived correction or the beginning of a more damaging bear market is yet to be seen. Keep in mind that while earnings have continued to rise, year-over-year growth estimates are slowing. This is a key point to consider —  over the past five years more tech-heavy indexes, such as the Nasdaq-100 Index, have been able to outperform the S&P 500 Index thanks in part to the ability of growth companies to surprise analysts on the upside.

Below is chart showing the aggregate earnings surprise for the Nasdaq-100 Index versus the S&P 500 Index for the past eight quarters. Calculating earnings surprise is simply dividing the unexpected earnings (actual earnings minus estimated earnings) by the estimated earnings. For example, during the most recent quarter, the Nasdaq-100 Index provided earnings 10.2% above expectations while the S&P 500 was 6.6% above expectations. As seen below, the Nasdaq-100 Index has had higher earnings surprises in all eight quarters compared to the S&P 500.

Source: Bloomberg L.P., as of Nov. 30, 2018

A possible FANG+ catalyst?

Continually beating expectations is a tall order for any company. However, given the very negative sentiment (and increased volatility) that has recently developed in response to geopolitical and economic events, it is possible that expectations may have been ratcheted down too much. With the earnings power of the FANG+ stocks still relatively attractive, in my view, we may see continued strength in 2019.

Investors looking for exposure to the Nasdaq-100 Index may consider the Invesco QQQ exchange traded fund, which is designed to track this index.

 

1 Source: Bloomberg L.P., as of Nov. 30, 2018

2 Source: Invesco, Alphabet (Google) class A and C, Amazon, Apple, Facebook, Microsoft and Netflix comprise 4.14%, 4.78%, 10.29%, 10.76%, 4.23%, 10.61% and 1.55% of Invesco QQQ (respectively) at Nov. 30, 2018.

3 Source: Blomberg L.P., as of Nov. 30, 2018, the return for Alphabet (Google) was calculated using the class A shares.

Important information

Blog header image: Thorsten Spoertein/Shutterstock.com

The Nasdaq-100 Index includes 100 of the largest domestic and international non-financial securities listed on the NASDAQ Stock Market based on market capitalization. An investment cannot be made into an index.

There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The Fund’s return may not match the return of the Underlying Index. The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risk associated with an investment in the Fund.

Investments focused in a particular sector, such technology, are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.

John Q. Frank, CFA
Equity ETF Strategist 

John Frank is the Equity ETF Strategist representing Invesco’s exchange-traded funds (ETFs). In this role, Mr. Frank works on researching, developing product-specific strategies and creating thought leadership to position and promote Invesco’s equity exchange-traded funds (ETFs).

Prior to joining Invesco, Mr. Frank was an Assistant Portfolio Manager at RS Core Capital, a multi-asset class investment firm. In this role, his primary responsibilities included research, risk management and asset allocation with a focus on the equity and hedge portfolios. Before RS Core Capital, he spent six years at J.P. Morgan Asset Management advising institutional investors on asset/liability management, asset allocation and pension regulation and worked across the defined benefit, defined contribution, endowment and foundation segments. He began his career at General Electric in a leadership development program where he was placed within the GE Energy division.

Mr. Frank earned a BSE degree in industrial & operations engineering from the University of Michigan – Ann Arbor and an MBA with Honors from the University of Chicago Booth School of Business with concentrations in analytic finance, econometrics, and statistics. He is a CFA charterholder and a member of the CFA Society of Chicago as well as the Beta Gamma Sigma Society.

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