How Big Tech got even bigger in the Covid-19 era

Big Tech has powered the ferocious stock market rebound from the coronavirus sell-off, defying expectations that an economic downturn would bring an end to investors’ love affair with fast-growing but expensively priced stocks. 

The so-called Fang stocks — originally Facebook, Amazon, Netflix and Google, but with Microsoft and Apple also often thrown in to the mix — became emblematic of the US technology-driven rally after the global financial crisis of 2008.

They helped drag the S&P 500 up by nearly 400 per cent from its 2009 low to the beginning of 2020, leaving many other equity markets in Europe and Asia in the shade. The more tech-oriented Nasdaq 100 index climbed more than 700 per cent over the same period. 

This stretched valuations. A key measure of that — the ratio between the Nasdaq 100 companies’ share prices and expected earnings — rose to more than 25 at the start of this year, against a 10-year average of 19, according to S&P Capital IQ figures. Many analysts expected the stocks to fall back to earth when the next downturn came.

Instead, the sector has reasserted its dominance in the coronavirus era, with the Nasdaq 100 climbing 15 per cent in April to end up back in positive territory for the year. The price-to-earnings ratio has now stretched towards 28 as earnings have slumped but stocks have rebounded.

“It was a narrow bull market driven mainly by one sector, and typically this is the sector that is sold the hardest when it ends,” says Luca Paolini, chief strategist at Pictet Asset Management, and one of many analysts who thought the era of tech stock supremacy would end. “But what is interesting is how tech-friendly this recession has been.”

Line chart of Nasdaq 100 forward price/earnings ratio showing Valuations on tech-heavy Nasdaq rebound after virus sell-off

With millions cooped up at home, companies like online retailing giant Amazon and internet streaming service Netflix are clear winners. They are both up about 30 per cent so far this year. Zoom, the video conferencing company, is another victor, doubling in value in 2020. Microsoft, which has also benefited from the video-calling boom, is up more than 10 per cent. Google, Apple and Facebook are also now roughly flat for the year, after each falling more than 30 per cent from the February highs.

This is part of a broader trend of stronger, less indebted companies doing well, as investors fret over the impact of an economic lockdown. Talk of introducing stricter regulations around privacy and concerns about digital monopolies have also faded from the political agenda as the coronavirus crisis dominates. This has added to the tech sector’s tailwinds.

As a result, the five biggest constituents of the S&P 500 — Microsoft, Apple, Amazon, Google’s parent Alphabet and Facebook — now account for a fifth of the entire index’s market capitalisation. That is a modern-day record in terms of concentration, Goldman Sachs notes, and comes with potential risk for investors.

“Narrow breadth can last for extended periods, but past episodes have signalled below-average market returns and eventual momentum reversals,” David Kostin, chief US equity strategist, warned this week. 

He admits to sharing the “incredulity” of many investors that the S&P 500 is now just 14 per cent below its all-time high, despite the biggest economic shock in a century, but calculates that the median stock in the index is still about 28 per cent below its high.

Typically, such narrow rallies end either when investors crowd into the market leaders but fail to justify their inflated valuations, or when an improving economic outlook helps laggards catch up. Increasingly, it is looking like investors are betting on the former outcome. 

The April rally has also been helped by a huge comeback from beaten-up energy stocks, as investors have bet that some of the gloom surrounding the industry is overdone. Despite US oil prices briefly plunging into negative territory last month, energy is the best-performing sector of the US equity market this month, up about 30 per cent.

European stocks have also bounced back since the worst of the sell-off, but the Stoxx 600 index rose just 6 per cent in April, and remains down 18 per cent for the year. The lack of big technology stocks in the region has been a drag, but index heavyweights such as L’Oréal and Nestlé are now nearly flat for the year, having weathered the early part of the crisis. Healthcare company Roche has gained 8 per cent thanks to its testing expertise.

In Asia, the Chinese “Bat” stocks — the local equivalent of the Fang stocks — have been more of a mixed bag. Search engine Baidu is still down 20 per cent this year, after an advertising drought hit sales, while online retailer Alibaba is down just 6 per cent and Tencent’s thriving online gaming platform has helped its stock erase its March losses to climb 11 per cent this year.

Some of the coronavirus-era stock market winners are likely to stay buoyant once the crisis recedes, as the outbreak accelerates existing trends such as online streaming and shopping. But in some cases analysts say high valuations will be a risk if growth fails to justify investors’ faith.

Yet the biggest question is whether the global stock market rally is sustainable, or merely a temporary — if powerful — bounce, engineered by central bank and government stimulus packages that will fade as the virus’s economic destruction hits. 

“Many promising bear rallies fizzle as the initial euphoria clears and the grim realities of underlying fundamentals come to the fore,” said Andrew Lapthorne, a strategist at Société Générale.

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