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Big-six tech fuel the logic-defying US market rebound: Brianstorm

Brian Han  |  27 Jul 2020Text size  Decrease  Increase  |  
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This is an extract from Morningstar senior equity analyst Brian Han's monthly column Brianstorm. Morningstar Premium subscribers can view the full version and previous columns here.

There is a common misconception the health of a stock market is representative of the underlying economy. This is understandable, given wider macroeconomic conditions are circularly tied to the revenue, earnings and cash flow of companies listed on an exchange—the key determinants of their intrinsic value that, in turn make up the stock market. However, there are times when a stock market’s health is completely divorced from economic reality.

Take the S&P 500 index in the US. Rightly or wrongly, it is THE bellwether benchmark whose performance often sets the tone for stock markets of many developed countries to follow. Judging by its performance since the start of 2020, and especially from the COVID-induced depth in late March, one may be forgiven for thinking “What coronavirus?” or for declaring the US a “Teflon economy!”.

But delve a little deeper and you will find the resilience of S&P 500 has almost entirely been underpinned by the technology sector. The “can do no wrong” cohort has returned 18.1 per cent so far this year (versus S&P 500’s 0.7 per cent) and now makes up 33.7 per cent of the US index on a market capitalisation-weighted basis, more than twice the next largest, the consumer cyclical sector which has a 14.1 per cent weighting. And in case you were wondering how S&P 500’s forward price/earnings multiple ever reached the current ritzy 25.5, the 39.3 average commanded by the technology sector provides an obvious clue.

S&P 500 performance driven by technology sector—Hardly representative of US economy

exhibit2

* Apple, Microsoft, Amazon, Alphabet (Google), Facebook and Netflix
Source: Thomson Reuters, Morningstar estimates

What is even more remarkable is the performance of the technology Big Six in the form of Apple (NAS:AAPL), Microsoft (NAS:MSFT), Amazon (NAS:AMZN), Alphabet (NAS:GOOGL), Facebook (NAS:FB) and Netflix (NAS:NFLX). Collectively known as the Microsoft+FAANG gang, and dominant providers of arguably the most cherished products/services if one was ever in a pandemic-induced lockdown, this group has left an indelible bite mark on the broader index.

Their shares have on average surged 38.8 per cent in 2020 year-to-date; their combined market capitalisation accounts for 24.2 per cent of the S&P 500 index total value; and they trade on a forward price/earnings multiple of 64.6. Such has been the ascent, shares in the Tech Big Six (with the sole exception of Netflix) have more than closed their discounts to our analysts’ fair value estimates since the start of 2020, and are now showing very little value relative to Morningstar analysts’ current assessments.

This is even after the valuation upgrades put through by our US technology analyst, Ali Mogharabi, on Alphabet (Google) and Facebook on 8 July, not to mention the recent plans by big advertisers such as Coca-Cola Co (NYS:KO), Starbucks (NAS:SBUX), and Unilever (NYS:UL) to pause or reduce advertising spending on social media in protest against the lack of controls to limit hate speech and misinformation.

Yet, despite the stock market performance of the US technology sector, it speaks for just 12.1 per cent of the aggregate revenue of all companies listed on the S&P 500 index, 16.2 per cent at the aggregate profit level and employs just 10.3 per cent of all the people hired by the constituent entities of the index. These percentage figures are even smaller when looking at the Tech Big Six whose combined revenue represents just 7.6 per cent of the index aggregate and employ only 4.9 per cent of the workers. All these figures would be even smaller as percentages of the entire US economy, given the significant number of companies and small businesses, especially in the struggling consumer discretionary industries, that are not listed on the S&P 500.

Viewed through this prism, is it any wonder there appears to be a parallel universe between the US stock market and the US economy? The resilient performance of the former is driven by the technology sector whose representation of the wider economy is relatively small, many of whose employees are sitting on bean bags, playing ping-pong and enjoying subsidised (or free) meals and perks while working on products/services which are in even greater demand in the current environment. The wider economy, on the other hand, remains in a coronavirus-induced funk with most Americans more worried about their jobs and health in the real world than the latest iOS update, trending hashtags and newest Instagram posts in the virtual world.

Read the full column, which includes a list of undervalued Australian stocks, here: Tick tech in the US, lift the barbell Down Under

is a senior equity analyst in the equity research team at Morningstar

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