The “FAANG” stocks are a small group delivering stellar returns, but their ascent isn’t the only reason the S&P 500 has risen to such a rich valuation, according to Rick Friedman and Anna Chetoukhina from GMO’s Asset Allocation team.
Facebook, Apple, Amazon, Netflix and Alphabet (Google) — the so-called FAANG stocks — are up 36% on average year to date through September.
Friedman and Chetoukhina consider whether the sharp rise in the S&P 500’s earnings multiple can be explained entirely by the changing sector composition of the index and its increasing tilt toward technology in their new Asset Allocation Insights piece — “FAANG SCHMAANG: Don’t Blame the Over-valuation of the S&P solely on Information Technology.”
“We know that the higher weight in the relatively expensive IT sector is driving some of the expensiveness of the S&P 500, but this does not fully explain the bulk of its high absolute and relative valuation level,” the pair write.
Ultimately, Friedman and Chetoukhina explain that it isn’t just tech.
“Quite simply, pretty much every other sector, save energy, is trading expensively relative to its median valuation since 1970. Yes, more of the S&P 500 is in the IT sector, which is relatively expensive versus other sectors historically and to itself today. But, with every other sector trading at P/E 10 levels far above long-term sector medians, it is easy to see why the overall market is overheated.”
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