By James T. Tierney, Jr.; Michael Walker

Defanged: Correlation between US mega-cap stocks recently crashed

Past performance does not guarantee future results.

As of April 29, 2022*Based on weekly returns for six shares – Alphabet Inc. (GOOG)(GOOGL)(Google), Amazon.com (AMZN), Apple (AAPL), Metaplatforms (Facebook)(Facebook), Microsoft (MSFT) and Netflix (NFLX) – using Friday stock closing prices of each week. Weekly return dispersion calculated using the Excel covariance function (VAR.B), to which a three-month moving average has been applied

Source: Bloomberg, S&P and AllianceBernstein (AB)

For several years, America’s biggest technology and new media companies were widely seen as a group of like-minded stocks. No more. The recent divergence in the so-called FAANG reminds us why fundamentals should always trump fads for long-term equity investors.

It’s one of the most well-known acronyms on Wall Street in recent years, although it’s gotten harder to pronounce. First came the FANGs – Facebook (now Meta Platforms), Amazon, Netflix and Google. Apple later joined to create the FAANGs, and more recently a revitalized Microsoft came on board the FAANMGs. The acronym reflected a popular view that these actions were made from the same mold. And their performance was highly correlated, especially during the pandemic, when demand for digital services soared. As a result, these six stocks accounted for almost 39% of the Russell 1000 Growth Index and 24% of the S&P 500 at the end of 2021.

The market correction amplifies the differences

A lot has changed during this year’s correction. While all six stocks fell, Netflix and Meta fell harder than the others. Correlation faded and returns diverged (Display).

Over the past few years, we have frequently warned of concentration risk in US equity markets. When the FAANGs rose in tandem, passive investors enjoyed handsome returns, but also built up a heavy weighting in the more expensive US mega-caps. In our view, each company should be researched and owned on its merits, using a disciplined investment approach and measured weightings.

Assessment of strengths and weaknesses

Even after the declines, US mega-caps are still important components of US indices, so they cannot be ignored. But an active approach is key to finding those that offer profitable and sustainable growth at the right price. The technology and media industries offer an array of business opportunities ranging from cloud computing, search engines and social media to online streaming, hardware and shopping.

Since each segment faces different dynamics and regulatory pressures, business outcomes will be different. Media streaming is seeing signs of saturation while becoming much more competitive. Social media incumbents fend off new competitors. Unprecedented inflationary pressures are adding barriers to e-commerce. The cloud is elevated by the digital transformation boom. Smartphones have become an indispensable utility, regularly updated.

Of course, all of this was true before 2022. But now the market is making the distinction that there will be winners and losers, unlike the last five years when everyone was seen as a winner. Assessing each company’s fundamental strengths and weaknesses is key to successfully investing in the right mega-cap growth companies for a more challenging macro and market environment.

The opinions expressed herein do not constitute research, investment advice or trading recommendations and do not necessarily represent the views of all of AB’s portfolio management teams and are subject to revision over time.

References to specific securities are presented only to illustrate the application of our investment philosophy and should not be considered recommendations by AB. The specific securities identified and described do not represent all securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified have been or will be profitable.

References to specific securities are presented only to illustrate the application of our investment philosophy and should not be considered recommendations by AB. The specific securities identified and described do not represent all securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified have been or will be profitable.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.