Tech Stocks: New Coronavirus Safe Haven?

FAANG group seems unscathed from economic turmoil wreaking havoc on others Continue reading... Read More...

How can one explain the unusual dispensation for one sector of the economy from the ravages of the sudden and economically devastating effects of the coronavirus when seemingly every other industry is untouched?

Prior to the lockdown, some analysts had been making a compelling case that many of the tech stocks, particularly some of the FAANG members, were reaching valuation levels that were simply inconsistent with present value discounting models. Skeptics might have anticipated that the current economic pain, thrust on every other business, would not have left the seemingly overvalued tech group untouched.

Instead, the group has been performing more like haven assets do in tumultuous economic downturns. As the market dropped, the tech group stayed relatively stable; during the rebound, it was the tech group that, true to form, led the rally. Because of their massive market capitalizations, technology stocks still command the largest weighting in many of the indexes.

The current market value of the FAANG group is larger than five other S&P 500 sectors. According to data from Dow Jones Indices, the five constituent members of the tech group comprise 20% of the value of the S&P 500 Index. That is up from 16% at the start of the year. Assign equal weighting to the tech stocks in the index and the entire S&P 500 would be down approximately as much as European stocks since the market peaked in February.

There are two principal reasons for the tech group’s allure and immunity from the overall economic carnage currently sweeping indiscriminately across the globe.

One is the staggering amount of cash on hand in the coffers of some of the largest tech companies. At the start of January, Microsoft (NASDAQ:MSFT) held $134 billion in cash and cash equivalents. Apple (NASDAQ:AAPL) had an enviable $58.89 billion free cash flow position on hand as of the end of December.

Many of these companies are uniquely positioned to take advantage of the mass migration from the workplace to home. Amazon (NASDAQ:AMZN) has seen a dramatic increase in business because already faltering high-leverage retail stores (like Neiman Marcus) that recently filed for bankruptcy have been closed. Netflix (NASDAQ:NFLX) recently posted a 15.8 million increase in new subscribers, mostly internationally, but all the same an impressive rainy day revenue cushion.

Despite the unfavorable business environment — crippled by the coronavirus effect — it is evident that investors still favor the tech group in these uncertain times. Shares of Netflix and Amazon both set new records last week; both stocks have shot up more than 28% this year, making them some of the top performers in the S&P 500.

Thus, while many pre-coronavirus S&P 500 companies were still enjoying decent earnings growth, once those businesses were forced to close, quarterly earnings crashed.

This indicates that consumer-sensitive businesses are going to feel pain for the remainder of 2020. With few corporations immune from the lockdown disruption, the FAANG group provides an oasis for investors who suddenly find themselves in a highly arid and unforgiving environment.

In short, in this peculiar business environment, technology stocks behave like a hybrid of traditional consumer defensive stocks while providing the stability of safe-harbor Treasuries, toward which investors always flock during periods of great uncertainty or economic retractions. “They are the old reliable and old standby for portfolio managers…Nobody is going to get fired for adding Apple stock in a downturn like this,” Mike Larson, a senior analyst for Weiss Ratings, said.

Despite the turmoil, the FAANG position still remains a crowded trade. According to an RBC analysis of S&P 500 companies, since March 17, hedge funds had invested the most money in the tech grouping.

Will the resilient technology stocks get their comeuppance once the economy rebounds, or when the decline of digital advertising shows up on quarterly reports, or if the specter of new burdensome regulations becomes more likely?

Perhaps. But for now, members of the FAANG group seem to be unencumbered by the economic leveling effect of the coronavirus. For investors at this time, that seems to be all that matters.

Disclosure: I have no position in any of the securities referenced in this article.