We could not resist using today’s cover photo of Bloomberg’s Day Break to illustrate this major post about the breakdown in US tech stocks and the FAANGs ( FAMANGs). Be they thanked here for the quality of their artwork.
Over the past few weeks we have been warning investors about a looming correction in equity markets – see STOCK CORRECTION AHEAD published on April14th 2021- and over the past few months we have been making the case that the secular rally in the US Technology Leaders was coming to an end, with a severe Bear market ahead of us – see LOOMING CORRECTION AND TECH SECTOR CRASH published on February 20 2021 and GET READY FOR THE COMING CRASH published on March 25th 2021.
We have been shorting the FAMANGs plus TESLA and AMD consistently in our MODEL PORTFOLIO and launched an index certificate with EXANE allowing investors to position themselves for the coming bear market in that sector and hedge their portfolios.
Looking at a Bear Market in the eyes
Let’s be extremely clear on the rationale that we have developed since 2018 to predict the end of the big US Technology companies.
They are all fantastic companies with phenomenal technological edges and massive franchises, selling services and products atet we all use in our daily lives and catering or billion of individuals and corporations around the world.
We are clearly not worried for their survival as corporations, businesses and profitable execution of their know-how.
However, even the best of businesses reach a stage where the infatuation of investors with the icons of our times leads their valuations to reach extremes that are unsustainable and the FAMANGs stock prices have been in a text-book bubble since 2018 with a vertical acceleration in their valuation metrics that cannot be sustainable.
The 2020 COVID health hazard pushed the phenomenon even further as most of these companies were great beneficiaries of the lockdowns and shift to “work-from-home” practices, and investors piled into them while selling the more traditional businesses.
To give a sense of the magnitude of the bubble, we have compounded below the rise of the 10 stocks composing the Mechelany Advisors’ US TECH SHORT Portfolio between the bottom of March 27th and the top they have reached in the past few weeks:
. Apple Inc. + 170.04 %
. Microsoft Corp. + 98.60 %
. Amazon.com + 116.51 %
. Netflix + 104.41 %
. Facebook Inc. + 142.02 %
. Alphabet Inc. + 141.00 %
. AMD + 170.70 %
. Tesla Inc. + 1278.28 %
These rates of appreciation are usually seen in penny stocks or young companies that are reaching the stage of profitability with massive growth potential, but it is unprecedented in the history of the financial markets to see well-established companies with in some cases decades of existence to experience such rises in their stock prices.
These are companies worth trillions or hundreds of billions of US dollars of market capitalisation that have either doubled or even multiplied by 10 in a single year, leading the Powell Bubble mania and sending their valuations to extremes unheard of in history.
2020 was an irrational year. 2021 is seeing the run to normalcy with vaccines being rolled out and economic growth catching up. In April 2021, these companies have reported bumper earnings for 2020 and even for the 1st quarter of 2021. Business conditions could not have been better, corporate earnings could not have been better and analysts revisions have also reached extremes of bullishness.
But these stocks have failed to move higher…
Supply / Demand is what makes a market
As is always the case in these situations, massive overvaluation and massive participation saw the seeds of major reversals and ensuing bear markets.
When the upward momentum ebbs and the stocks do turn, massive selling takes place with little if any buying on the other side of the trade, leading the fall to be sharp and very extended.
Since, the summer of 2020, many of these stocks have lost upward momentum and are now breaking down with massive heads and shoulders while the others peaked after their Q1 2021 earnings.
Investors and analysts are at a loss to justify paying such hefty premium to own these stocks when business prospects are indeed good, but certainly not in the 40 % growth that would be needed for decades to come to justify such valuations.
Moreover, the FED-engineered liquidity party is coming to an end … The Powell Mania has sent liquidity chasing each and every possible asset class into bubble territory, including commodities, while the generous blank checks served by the US Government to citizens makes them reluctant to go back to work explaining both the lack of job creation and the sharp increase in wages.
As a result bond yields have been soaring. And owning companies that are delivering extremely low earnings yield becomes difficult to justify when there is suddenly a much safer alternative.
What we are seeing now is a major technical break down that has the potential to become self-fulfilling and could lead to a crash in these corporate giants.
The DE-FAANGING of portfolios has probably started, and this will take an extended period of time considering the massive participation and weighting of these stocks in global portfolios and the indexes.
In last Weekend’s Annual address to shareholders, Warren Buffett was clever enough to apologise and present his massive selling of Apple shares in Q1 2021 as a “mistake”. The sage of Omaha is wise enough to know what he is doing while avoiding to send signals to the markets. Far from being a mistake, his wave of profit-taking was clearly deliberate and justified.
Cathy Wood, the one-time tech star who came to fame by riding the last wave of a speculative bubble, is seeing 91 % of her holdings take a massive beating while investors are leaving in droves.
Her flagship ARK Innovation fund has already lost 35 % of its value since February 2021 and far from being able to average down, she is now forced to sell positions to meet redemptions. She sold 30 % of her holding of Apple shares on Monday, feeding the downward spiral.
Finally, as the DE-FAANGING is taking place at a time where the Dow jones Industrial reached its all-time high of 35’000, the rout in the US tech mega caps has taken the Nasdaq 14 % lower and the SP500 5 % lower already.
Assessing the Downside
What we are currently witnessing is the top of the bubble in these overhyped stocks and a secular change in psychology.
Regardless of global market conditions and the behaviour of the main indexes over the reminder of the year, what can be said is that there is no rationale for these stocks to make new headways…
We have seen the best of earnings, shortages of components and chips are hampering the industrial china, rising commodity prices are pushing production costs higher and eating into profits, taxation will further reduce their margins, and last but not least, all these giants are now starting to face immense regulatory pressure and legal challenging of their de-facto monopolies – see the legal cases against Apple in the US and the UK – as we predicted long ago, major anti-trust cases being prepared against their business models.
It is therefore unlikely to see these stock making significant new highs and investors should be ready to carefully look at the potential downside before deciding to stay invested…
We look below at the various companies from a long-term technical pstandpoint
Apple Inc AAPL US
A look at the monthly chart gives a measure of the potential downside…
The natural regression line of the entire period between 2011 and March 2020 gives an indication of the normalcy of trading of this hugely successful company over a normal economic cycle. It is truly by the end of 2018 that the abnormal monetary policies pursued by Jerome Powell’s FED sent the stock outside of its normal comfort valuation zone.
Over the period form 2011 to 2020, the company’s net profits and earnings per share have clearly quadrupled, but the stock price has been multiplied by 10x.
Over the past two years, Apple’s rise had nothing to do with business but with an unprecedented and unsustainable phenomenon of valuation expansion.
Between 2011 and 2017, great years for the company, the Price to book ratio oscillated between 4 and 7x , already a hefty premium when compared to the general market then.
At the time, and despite similar earnings growth as is the case now, its P/E ratio was oscillating between 10x and 19x.
Since 2018 the Price to Book ratio has sky-rocketed to 31.7x and the P/E ratio to 29.6 x.
Now there is strictly NO Fundamental rationale for this massive surge in valuation over the past two years. Revenues are expected to grow barely 3.8 % in 2022 after the sharp 2020 catch up, and earnings per share by 3.5 %. !!! And that does not take into consideration the potential negative impact of having to change their business models or of additional takes.
Analysts may argue that Price to Book ratios differ from sector to sector and we fully agree with that, However, what we are comparing here is the PB ratio of the same company and the same sector over the long period.
What the above charts and valuation charts are telling us is that a reversion to the mean will take the Price to Book ratio of Apple back towards 11x ,
GIVING A PRICE TARGET OF US $ 57
or a 54 % decline from current price.
Microsoft Corp. MSFT US
Besides the divorce of Bill and Melinda Gates that could ultimately have an impact on the stock price, Microsoft is in a classical trend-ending vertical acceleration even if it is too early to call the final top.
The internal dynamics are deteriorating but the stock is still correcting within its uptrend for now. Only a break of the 240 and then the 224 level would signal the confirmation of the long term top.
Microsoft profitability metrics are good, but earnings per share are only expected to grow single digit in 2022,
Our Price Target in case of a break down and a reversion to the mean will give a Price target at US$ 93, a 61 % decline from current levels.
Amazon.com AMZN US
Amazon.com stellar results did not convince the markets and the stock lost 10 % of its value since the publication of its earnings on April 30th 2021. Since September 2021, Amazon has been inscribed in a horizontal consolidation channel which will either provide the base for another leg up, or if the channel is broken to the downside, the mark of a secular top.
The 2900 level must be watched with extreme attention.
At the end of the day, this 1.6 Trillion Dollar company generates only 50 Billion US Dollars of net profits, or barely 3 % yield. Earnings are now expected to grow at a slower pace, between 25 and 30 % as the company matures and extra revenues are more expensive to acquire.
AMZN is still a high growth company. The question facing investors is whether the current valuations reflect a potential plateauing of its earnings growth in the future.
We cannot exclude another leg up in the stock in the summer of 2021, but a break below 2’900 would mark the end of the rise.
Our TARGET PRICE in case of a mean reversion is at USD 1600, a 50 % decline from current levels, implying a 20x P/E ratio.
Netflix NFLX US
When investors are paying fro growth, they want growth… Netflix’s prudent guidance for future customer acquisition did not go down well with investors and the stock fell 10 %.
Netflix is now facing severe competition from new entrants in the video streaming market and it remains to be seen if new content will be sufficient to counter margin erosion.
The stock is trading in a well established consolidation channel and the 450 level must be watched carefully. The moving averages are telling a more negative story.
Netflix’s earnings per share growth should fall towards the low double-digit range. Can that sustain a 51x PE and a 17x Price to Book remains to be seen
A reversion to the mean would bring the stock down to 270, a 45 % decline form current levels.
Alphabet GOOGL US
Google delivered spectacular results in Q1 2021, beating expectations and delivering 111 % growth in net profits when compared to the same quarter of 2020. Nevertheless the stock fell and remains inscribed in a constructive upward trending channel for now..
Longer term, the stock price is in a vertical acceleration phase which will be difficult to sustain considering the 10.5 % growth in earnings per share expected for 2022.
A reversion to the mean would take the stock down to 1350, a 40 % decline from current levels.
Advanced Micro Devices AMD US
AMD rose from USD 1.5 to 99.23 between 2015 and January 2021, making it the most performing stock of the half-decade. However, since then, AMD is completing a Head and Shoulder configuration that, if confirmed by.a break of the 72 levels, will mark the end of its secular bull market.
The long term chart tells a scary picture and if the company should deliver a 100 % increase in earnings per share in 2021, the rate of growth is expected to fall sharply in 2022. Considering this environment, it is difficult to see how the company could make a new high in the future
A reversion to the mean would take the stock to US 30, a 60 % decline form current levels and a 15 x prospective earnings.
Tesla TSLA US
The EV company that made Elon Mush raise to the status of generational icon, imposing his will on the crypto sphere, is a textbook example of a speculative bubble. After having risen 1280 % since the March 2020 bottom, the stock has already lost 31 % of its value since its peak at 900 in January 2021.
The whole rise is over and the only thing ahead of the company is a significant fall.
Although the production and sales numbers for the first quarter of 2021 were good, the company reported 439 million US dollars of net profits after US$ 511 million of Carbon credits and 101 million of profits trading Bitcoins, meaning that the auto business is still bleeding losses.
Tesla is now facing massive competition from the traditional auto players from Volkswagen to general Motors and may even have to face revolutionary advances in battery technologies.
Tesdla’s bear market has aired<y completed its first leg. The second leg is in the making and will take the stock down to below 400, regardless of what Cathy Wood may say.
Together with JP Morgan’a analysts, we see the stock falling to US $70 in the next two years, an 88 % decline form current levels.
Whichever way investors are looking at it, the global psychology is changing vis a vid the FAANGs and the leaders of the secular bull market in place since 2009.
Investors are no longer ready to pay higher valuations and any break down in these stocks will lead to significant liquidation.
The risk – reward is not worth it and time has come to DEFAANG portfolios.
Using the EXANE SHORT US TECH certificate is also a good way to hedge a global portfolio
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