Investor euphoria about the growth prospects of big tech stocks, most notably the members of the FAANG group, has been a major factor propelling the S&P 500 Index (SPX) and other major market barometers upward in recent years. However, sentiment towards big tech has cooled noticeably, with the NYSE FANG+ Index down by 15% from its record high close on June 20. The FANG+ Index includes FAANG members Facebook Inc. (FB), Inc. (AMZN), Apple Inc. (AAPL), Netflix Inc. (NFLX), Google parent Alphabet Inc. (GOOGL), and "other popular tech names," per The Financial Times. The table below shows the performance of these tech leaders since June 20.

The FAANG Stocks Are Losing Their Bite

Stock or Index Gain Since June 20
NYSE FANG+ Index (16.1%)
Facebook (23.3%) 1.2%
Apple 15.8%
Netflix (16.8%)
Alphabet (7.3%)
S&P 500 Index 0.1%
Nasdaq 100 Index (NDX) (2.3%)

Source: MarketWatch; computed with closing prices on Oct. 18.

Significance For Investors

Tech stocks in general, and big names such as the FAANGs in particular, may face significant downside risk on price, and upside risk on volatility, as big investors look to take profits and reduce their tech exposure. As Michael Underhill, chief investment officer (CIO) at Wisconsin-based investment management firm Capital Innovations, told the FT: “The concentration of performance in the FAANGs over the last three years causes numerous investors to be concerned and rightly so. We need to see more depth and breadth of performance to the market to instill more confidence. That's why you aren't seeing more buyers." (For more, see also: Now is the Best of Times for FAANG Stocks.)

“The concentration of performance in the FAANGs over the last three years causes numerous investors to be concerned and rightly so." —Michael Underhill, Capital Innovations

Source: The Financial Times

The monthly Global Fund Manager Survey conducted by Bank of America Merrill Lynch indicates that positions in the FAANG stocks and in the Chinese big tech BAT group collectively have been the most crowded investments for 9 consecutive months, per the FT. The BAT stocks are Baidu Inc. (BIDU), Alibaba Group Holding Ltd. (BABA) and Tencent Holdings Ltd. (TCEHY).

A parallel concern is that the FAANGs represent a huge percentage of major capitalization-weighted stock indexes, such as 12.6% of the S&P 500, per Add in Microsoft Corp. (MSFT), and these 6 tech giants are 16.2% of the S&P 500. Should they stumble, they may set off waves of selling throughout the market as panicked investors react to tumbling indexes.

"We’re still meeting folks heavily concentrated in the U.S. and tech," as Darrell Riley, a portfolio strategist at money manager T. Rowe Price Group, told The Wall Street Journal, adding that the recent market retreat has “been a wake-up call.” T. Rowe Price has been encouraging clients to reduce holdings of U.S. equities and diversify with stocks in Europe and Japan, per the WSJ. Morgan Stanley recently issued a warning on tech stocks, noting that they have gone relatively unscathed so far in a generalized reduction of valuations that has been sweeping the market.

Looking Ahead

Rising interest rates are exerting downward pressure on equity valuations. The impact on tech stocks can be particularly significant, since their current values often reflect extreme investor optimism about projected earnings far off in the future. Now the present value of those earnings is declining precipitously, as the discount rate applied against them is rising. (For more, see also: 4 Stocks to Outperform in an Anti-FAANG Portfolio.)

Also, decelerating economic growth will exert downward pressure on these companies' own growth prospects. So far, however, Netflix has impressed investors with a strong 3Q earnings report that beat expectations, and Apple has bucked the trend with strong gains since June, as the table indicates.