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Without FANG this Market isn't worth a DANG
US stocks are poised to notch a seventh straight year of gains but there are signs this bull market may be long in the tooth (pun intended).
One cause for concern is the lack of "market breadth”. This occurs when the market's performance is driven by only a narrow sliver of companies. The result is a select few stocks so dominate that they mask what is going on with the rest of the market. The large cap S&P 500, for example, is near its all time high but, on closer look, its modest ascent in 2015 is due entirely to the strongly positive average performance of the largest 90 stocks which have more than offset the negative average of the 410 remaining, smaller companies.
The tech heavy Nasdaq 100 presents an extreme case. The broader Nasdaq composite recently breached its record highs that dated back nearly 15 years ago to the bursting of the dot-com bubble. Within the Nasdaq 100, however, just four names are driving the average back toward new record highs. These four companies, Facebook, Amazon, Netflix and Google are together known by the acronym "FANG". To illustrate, counting FANG the Nasdaq 100 is up +10% for the year. Without FANG, the Nasdaq 100 is down -5%.
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Especially for cap-weighted indices like the S&P and Nasdaq (the Dow Jones is price weighted) the biggest companies have the greatest impact. When the bigger companies within the S&P and Nasdaq are doing well it can appear as if the entire market is gaining even though the vast majority of stocks may actually be going in the opposite direction. Market pros maintain an extra dose of skepticism when they know a market is being driven by a narrow subset of companies because they recognize it may paint a rosier picture of the overall stock market than is actually deserved.
Also worth noting, active stock management tends to produce a greater divergence from the average in markets with low breadth because being right or wrong about the comparatively few winners can have an outsized impact on return. In 2015, managers that emphasized larger company stocks (which could include FANG) have tended to do quite well compared to overall averages. Conversely, 2015 has been a very long year for those managers that underweighted the large cap companies.
Ned’s Notes Takeaway: Celebrate your own good results should you have them, but remain focused on what happens going forward. Leaders in one particular market environment are often followers in the next.
Addendum: Neds Notes is a proprietary newsletter created by none other than Ned. Feel free to forward it to others as you like but its contents may not be used for commercial purposes without the express consent of the author. .
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