Does Facebook crash signal end of FAANG rally?

Investors are seeing a growing divergence within the FAANG basket as companies mature and start to tweak their business models, according to Tom Bailey.

For the past few years, so called FAANG stocks (Facebook Inc A, Apple Inc, Amazon.com Inc, Netflix Inc and Alphabet Inc A,) have seemed unstoppable. Despite the warnings from bears that we were in a new tech stock bubble and the shares were trading far above fair price, valuations continued the rise. This year too, FAANG stocks have been the strongest performers on the US market. Indeed, without the growth of FAANG share prices, the S&P 500 would be in negative territory in the first half of 2018.

July, however, may turn out to be a turning point for the tech giants. Earlier this month Netflix’s share took a dive by around 15% following missed growth expectations, while last week (week of 23 July) Facebook lost around 20% of its market value after releasing much lower earnings guidance.

Does this signal the final throes of the FAANG trade? Has the tech bubble finally popped? Not quite. While Facebook and Netflix have had a rough month, Amazon and Apple shares held up after both posted strong second quarter results, while Google has seen positive, albeit lagging, performance.

Instead, it seems what investors are seeing is a growing divergence within the FAANG basket as companies mature and start to tweak their business models.

Facebook is the clearest example of this. The company;s guidance on lower earnings growth, for instance, was the result of expectations of a changing and maturing business model. "Facebook is changing the way they want users to engage with the site," says David Older, head of equities at Carmignac.

Facebook previously attempted to curate news and content for users, which was the perfect environment to serve advertisers, allowing them to target exactly the audience they wanted on the platform. However, Facebook decided this was having a negative effect on user experience, says Older.   

As a result, the company is now attempting to re-emphasise user-generated content over curated third-party content, which may result in less advertising-generated revenue. Older argues this has created concern among investors that Facebook will "have a sharp slowdown in revenue growth for the second half of the year."

"People looked at the revenue trajectory and realised it’s a much less profitable business over the next few years. It was a completely rational reset of the stock price," he notes.

Walter Price, manager of Allianz Technology, also sees Facebook's changing business model as the main drag on price. "Core Facebook is maturing and growing modestly, while new initiatives with Stories on FB and Instagram advertising are growing fast but will take some time to become meaningful," he says.

Attempts to better filter and remove fake news or incendiary content will weigh on the company's costs, while new video initiatives will require additional costs in the form of new data centres. "This means that the company is in a period of slow or no earnings growth for the next year or so."

As result, Price has reduced his holdings:

"Our [Facebook] position in the fund is now less than 2%. We were less than 4% going into the call because we were concerned about slowing growth, but earnings growth slowed more than we were expecting."

Likewise, Netflix is also in a period of transition. "We think Netflix is in a period of consolidation until investors understand whether the last quarter was a perturbation in the trend to higher subscriber growth or a sign of maturity," says Price. The streaming company accounts for 2% of his portfolio.

In contrast, Price is still bullish on Amazon, which now accounts for 6.9% of the trust’s portfolio. "Amazon had a good quarter as we expected," says Price.

"Advertising strength continued to exceed expectations, and Amazon Web Service (AWS) logged another quarter of higher growth rather than decelerating as many analysts had expected."