The fragility of the current bull market is known by everyone. There is too much uncertainty regarding the markets' performance in 2016, and it is also commonly assumed now that the current state of the markets is strongly dependent on the price dynamics of its best performers. The top performers have nearly become the face of the rally we were observing, but they are also capable of bringing an end to it. Even though the bull market might last for many additional months or even several years while continually ignoring the fundamentals, it is crucial to understand the responsibility that has been assigned to the markets' darlings. Should they fail in 2016, the expectations for the whole stock market might sink. This article is focusing on "FANG" stocks, as large market capitalizations and decent performance have probably made them nearly the most important stocks to watch in 2015.
"FANG" stocks have been one of the brightest spots in the stock market this year. "FANG", which stands for "Facebook (NASDAQ:FB), "Amazon" (NASDAQ:AMZN), "Netflix" (NASDAQ:NFLX) and "Google" (NASDAQ:GOOG) (NASDAQ:GOOGL), has been a major contributor to the fact that the S&P 500 is still not negative year-to-date. Possessing a total component weight of 5.58% in the S&P 500, these 4 stocks have been successfully providing the index with fuel over the course of 2015. The graph below represents the year-to-date performance of a "FANG" index, which is created using a hypothetical portfolio consisting of $1 bln invested in each of the 4 stocks on the 2nd of January, 2015. As of December 27, FANG has produced gains of 83.19%, which is quite distant from the S&P 500 gains of 0.1%.
Source: Nasdaq. Note: GOOGL stock was used for the Alphabet part.
The sluggish performance of the index might be attributed to the bad performance of smaller cap stocks. However, the stock market was not too generous towards the larger companies as well. Throughout this year, the 44 largest S&P 500 companies with market capitalizations in excess of $100 bln have only appreciated by 9.04% on average.
If out of those 44 stocks one would only include the 25 S&P 500 components with the largest weight in the index, the average year-to-date performance would be +11.76%, which is the equal weight return of nearly a third (32.76%) of all S&P 500 stocks this year.
The difference between the 11.76% figure and the overall index performance raises questions regarding the other, less-known S&P 500 stocks' performance. Moreover, if we exclude GOOG, GOOGL, FB and AMZN (NFLX is not in the top 25 by weight) from this equal weight index, the year-to-date return of $100 bln S&P 500 companies becomes a surprising 2.83%.
The chart below demonstrates the performance of the total S&P 500 equal weight index, which lost 3.17% year-to-date.
S&P 500 Equal Weight Index, 2011-Present. Source: S&P Dow Jones Indices.
The fact that only a tiny part of the whole S&P 500 is, to a certain extent, responsible for holding the whole index above water might be surprising. What is more surprising, however, are the valuations the market has given to them over the course of this bull market. As long as valuation metrics demonstrate how much an investor is willing to pay for the underlying business, valuation is capable of demonstrating the overall attitude towards the stock, as well as its popularity among the investors. It is hard to deny that skyscraping valuations suggest that FANG stocks are increasingly popular among both institutional and retail investors, as it is impossible to ignore the buzz they are creating on a daily basis. Even though it is reasonably certain that these 4 companies are not likely to experience drastic revenue decreases in the coming years, the expectation cycle might turn away from FANG, as it did for many similar stocks (despite the strong revenue growth, AAPL's P/E and P/B ratios have never recovered to the highs of 2007-8).
But what does it mean for the FANG stocks? Even though it is not likely that they will be among the worst-performing stocks any time in the near future, the crowd might easily forget the emotions associated with these stocks at some point. I guess it is quite easy to come up with numerous examples of stocks that reached the peak of their popularity at one bull market and quickly became much less demanded in the consequent ones (one possible explanation might be the fact that, due to higher valuations at the end of a cycle, market darlings tend to be valued higher at the beginning of a new bull market, passing the scene to the undervalued value stocks and newcomers). It is not impossible that the FANG stocks will start experiencing sluggish performance in 2016, and it is increasingly possible that the market will carefully watch, if not follow the route these stocks are about to choose in the coming year.
But what about the inverse effect? As I have discussed above, the equal weight version of the S&P 500 is already negative this year. There is no such performance that is capable of making a stock invincible, and FANG stocks are no exception. Nevertheless, it can be seen below that the FANG's ultra short-term outlook does not seem bearish for the time being.
The performance of FANG is just as dependent on the broad market as the overall market is dependent on FANG. The short-term trend of the U.S. stock market has become quite unclear. Even though it might be the time to recall the fundamentals and start preparing for the beginning of a bear market, it is completely understandable that the rally can go on for longer than most of us expect. The way the market will start the year is all that matters. In case the trendless route ends on a pessimistic note, low-volume cautiousness might turn into a high-volume sell-off.
There is also one other fact to consider before making predictions for the FANG performance next year. FANG stocks were clearly not the biggest winners this year, as 2015 has been a tremendous year for many smaller (mostly, biotech) stocks. Even though FANGs did not even make it to the top 30 (NFLX currently has the 33th spot), the year-to-date performance of NFLX and AMZN is close to that of the biggest S&P 500 performers of 2014.
Source: USA Today Money.
Among the biggest S&P 500 winners of 2014, average year-to-date performance this year was +14.58%, as opposed to already-mentioned +83.19% delivered by FANG. Food for thought.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.