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Portfolio > Economy & Markets > Stocks

Is the Tech Rally Over or Just Taking a Breather?

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It was bound to happen, the selloff in the top tech stocks — now known as the FAAMG stocks (for Facebook, Apple, Amazon, Microsoft and Google who’s parent company is now Alphabet). In late April the tech-heavy Nasdaq closed at its highest level since the tech bubble and in late May Amazon finished above $1,000 a share for the first time. Then on Friday, four of the five FAAMG stocks fell 3% or more while Amazon dropped 2.6% and the Nasdaq lost almost 2%, raising the question: Is this tech rally, too, over?

(Related: US Stocks ‘Deeply Overbought’: Russell)

The catalyst for Friday’s decline was a Goldman Sachs report, which noted that the growing momentum in these stocks “has built a valuation air pocket underneath it creating cause for pause.”

The Goldman report also said that the volatility of these stocks is extremely low — below that of consumer staples and utilities — which is attracting investors, including passive low-vol funds, who might “underestimate the risks inherent in these businesses …. The fear is that when fundamental events cause volatility to rise, these same passive vehicles will sell and exacerbate downside volatility.”

FAAMG stocks, as a group, constitute a crowded trade, according to Goldman, comprising 13% of the S&P but accounting for close to 40% of its year-to-date performance, and 42% of the Nasdaq 100 index but 55% of its gains year-to-date.

In addition, according to Goldman, free cash flow for FAAMG has plateaued after doubling between 2006 and 2016, and rising stock prices and more capital expenditures have eroded annual cash generation. At the same time, the five stocks constitute 11.8% of mutual fund holds for core, growth and value, versus a blended benchmark of 11.2%.

On the plus side, however, Goldman notes that FAAMG stocks as a group are not as overvalued as they were during the tech bubble, trading at 23 times forward two-year earnings — compared with 60 times during the bubble, although Amazon trades at over 30 times, and free cash flow generation is still relatively robust after having doubled over the past 10 years.

Brad Sorensen, managing director of market and sector analysis at Charles Schwab, doesn’t expect much follow through on Friday’s selloff in FAAMG and other tech stocks and anticipates further gains.

The selloff, said Sorensen, is not based on any real fundamental change in the sector. “I don’t see a lot of follow through because the story hasn’t changed. Investors are still looking for growth because growth is hard to come by.”

Still, Sorensen would like to see a pickup in capital spending by tech companies. “We’re starting to see that, but if it should start to retrench and companies get nervous about geopolitics, the Fed, or the economy that would make us concerned.” In the meantime, he says the sector is “still relatively healthy.”

Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors, agrees. He sees opportunity for additional gains in tech stocks, which have yielded double-digit earnings growth over the past two quarters and the highest amount of earnings surprises this year.

“Let’s see what happens Monday,” says Sorensen.

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