FANG Stocks Still Dancing, But Investors Should Be Wary

FANG stocks are partying like it’s 1999.

An index of these stocks – Facebook, Apple, Amazon, Netflix, and Google (now Alphabet) – constructed by the New York Stock Exchange returned a stunning 58.4% in 2017. Revenue and profits for most of these companies continue to rapidly grow, and if the current market environment continues, FANG stocks could climb a little farther.

These five stocks accounted for roughly 12% of U.S. equity market capitalization at the end of last year. If stock prices rise at the rate Wall Street expects over the next three years, four of these companies will have market capitalizations over $1 trillion. And all five companies will account for more than 15% of the S&P 500’s value.

But buyers beware. If you enjoyed the FANG run-up using an index fund or an active manager applying a growth-investing approach, you might not like the downside. The collapse in valuations that typically follows a stumble in fundamentals (revenues and profits) and/or a change in the stock market’s pricing paradigm is remarkable. This is particularly true as large companies face the law of large numbers, and long-term earnings growth expectations drop. Every few years market leadership changes, and history is dotted with past FANG facsimiles such as the “Nifty 50” of the late 1960s or the “TMT” (Tech, Media, Telecom) of the late 1990s.

Active managers can help buffer the impact of a drop in FANG stocks. Managers that apply a blend or value approach to investing are likely to be underweight in FANG stocks relative to the S&P 500. While FANG stocks may run higher for some time, many managers are likely to try to limit the risk of a price collapse as has happened to similar stocks in the past.