Is the Facebook Flop a Sign of Market Trouble to Come?
(Bloomberg Businessweek) -- It’s not new to say that we see the world through Facebook Inc.’s eyes. That’s increasingly true for the market as well.
Last week, a trade truce between the U.S. and the European Union, expectations of a strong number for gross domestic product growth, which only slightly underdelivered, and corporate earnings likely to top 20 percent growth should have pushed stocks steadily higher. Instead, on Thursday, the day after the trade announcement, stocks slumped. On the other side of the ledger: an earnings report from Facebook in which revenue rose 42 percent, instead of an expected 43 percent. It was read by investors as a disaster. The company lost more than $100 billion in market value.
Facebook could lose that much, of course, because it’s also one of the market’s most valuable companies—worth some $505 billion even now. And yet it seems strange to think of Facebook as a bellwether. It’s not directly tied to the big force driving the U.S. economy, consumer spending. Its revenue is from advertising, but that revenue is more dependent on the usage of its growing and still relatively young social network, not the economy or even the advertising market broadly. (Google parent Alphabet Inc. would be a better indicator of that.) Facebook’s profit margins are much higher than those of the rest of corporate America. And it has less at stake in the current trade battles than many other companies. It’s basically blocked in China.
Even so, Facebook has become a leader of the group that’s led the market. It’s the “F” in the famous FAANG, the acronym for the group of big tech darlings that also includes Amazon.com, Apple, Netflix, and Alphabet’s Google. Since Donald Trump won the presidential election, the total market capitalization of the stocks in the S&P 500 has risen $6 trillion. Half of that gain has been in tech, and almost half of that, or more than $1.4 trillion, has been in the five FAANG stocks.
Strategists such as James Paulsen of the Leuthold Group point out that that kind of dependence on the gains of a few stocks is common of market peaks. “The character is different, but we have seen this before,” he says. But the market has been more concentrated before. The five largest stocks accounted for 17 percent of the S&P 500’s market cap at the end of 1999, more than the 14 percent today. Nor is it unique for the top five stocks to be pricey. In late 1999 the average price-earnings ratio, based on the past 12 months, was 71. Now it’s 58.
What’s different is that even at the height of the dot-com bubble, two of the five largest stocks in the market, General Electric Co. and Walmart Inc., were from outside the tech industry. In late 2007, when the market peaked before the financial crisis, only one tech stock, Microsoft Corp., was among the market’s top five. These days all the top five are tech companies, although not quite the FAANG group—Microsoft is in today’s top five; Netflix isn’t.
Another difference: While tech stocks make up 30 percent of the value of the S&P 500, slightly more than they did in 1999, they also make up 23 percent of next year’s expected earnings for the S&P, up from 15 percent in 1999. So not only are market values increasingly driven by tech, but the economy is, too. What’s more, what we consider tech has changed. In 1999 the five biggest tech companies were Microsoft, Cisco Systems, Intel , Nokia, and International Business Machines—all companies that made the software and hardware used by others to become more efficient.
These days not only is the tech sector bigger, but more and more of the economy, in all sectors, is towered over by tech companies. Amazon is the nation’s most important retailer, not just one with a market value that’s $500 billion larger than the value of Walmart and Costco combined. Alphabet dominates the advertising industry, and even has a foot in the auto business with its self-driving car company, Waymo. Netflix is as much a part of Hollywood and the media landscape as any other company.
And that’s where the growth is. Stock values are elevated these days in part because the profits of public companies tend to be growing faster than the rest of the economy, with profit margins at all-time highs. Facebook could be a canary-in-the-mine there. It also could prove to be an early indicator of how the government plans to deal with big tech’s dominance of information and media.
All this could add volatility to the market, because investors are far more jittery about Facebook and the rest of the FAANG stocks’ future, and because the group’s continued dominance is far from certain. Of course, that was also the case when comparatively stolid Walmart or General Motors were among the market’s top stocks. Even if investors then didn’t realize it.
Stephen Gandel is a Bloomberg Opinion columnist.
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