The Future Of The Stock Market And The Future Of The FAANGs

Summary

• The FAANGs constitute about one-eighth of the S&P 500 Index and can exert a major influence on what happens to the overall index, so their future has important implications.
• The FAANGs are constructed differently than "older" conglomerates like General Electric and so must be looked at differently when assessing their strength and their behavior.
• The bottom line: we must understand more about the FAANGs and how they function in order to understand their performance, understand their construction so that we don't over-regulate them.

There have been many expressions of concern over the size and influence of the FAANGs…Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX) and Alphabet's Google (GOOG) (GOOGL)…and this concern extends to their role in the stock market.

According to Bespoke Investment, as reported by the Financial Times, "The FAANGs account for about one-eighth of the S&P 500 Index's total value…."

Even more amazing, however, is that "they have provided half the market's growth this year."

In terms of the recent market decline, "Share price falls after disappointments from Netflix, Facebook and the smaller Twitter, have left the broader Fang+ index of technology companies down almost 10 percent from its June high, despite strong results from Apple."

Going further, "tech's share of the wider index is now the highest since the dot-com boom."

But, in the dot-com boom, "Big Tech" was much smaller and was made up of many early stage companies that the opinion writer at the Financial Times refers to as "flimsy companies with no profits."

One cannot compare that earlier time with the present, for "Today's tech leaders have viable models and real earnings."

But, one cannot ignore the fact that the current stock market is so dependent upon just a small number of very large companies, in terms of market valuations. And, these very large companies represent the direction that the "new" Modern Corporation is going.

I have written quite a lot over the past three months or so about the "new" Modern Corporation and it interesting to see that investors are giving the greatest attention to companies that seem to be the primary representatives of this transition to the future.

This "new" Modern Corporation primarily deals in "intangibles" connected with intellectual property. The intangibles are easily integrated into networks that thrive on increasing returns to scale.

Working with this business model, the old model of the conglomerate retreats into the shadows, as the creation of "intangibles" overcomes the production of the physical. This is seen in many recent acquisitions with Apple, Inc. and Amazon.com serving as the leading examples.

Where this activity signifies significant strength, the fate of the conglomerate, the aggregator of a portfolio of independent industrial manufacturers, appears to capture the shortcomings of past dreams. Of course, the demise of General Electric (GE) seems to capture what can go wrong with the conglomerate.

And, to me, the announcement by General Electric that it will shed parts of its digital unit just underlines the lack of understanding on the part of GE's CEO John Flannery and his team about where the modern corporation is going.

Former GE CEO Jeff Immelt may not have gotten everything right in his move to build up the software unit of the company and produce industrial networking, but, in my mind, he was heading in the right direction for the twenty-first century.

The future of GE represents a return to the past and a concentration on "tangibles."

And, this is why I believe that investors are concentrating so heavily on the FAANGs and "Big Tech." These companies represent the future. They are constructed differently. And, others are lagging behind.

This difference is captured in the "three lessons" the Financial Times author writes that we should draw from "recent weeks."

First, the author focuses that "the FAANGs are unusual in becoming corporate titans while maintaining growth rates more akin to startups."

This seems to be because the economics of "intangibles" are different from that of manufacturing firms. High growth companies can disappoint and lose future growth, but the nature of these tech companies revolves around the fact that "intangibles" are constantly being upgraded and new generations are forever coming down the path.

Second, the author suggests, "Concerns that core businesses are maturing are justified." That is, these tech giants need to diversify and spread out. And that is what they are doing. Of course, some are doing better than others, but so much of the diversification is being done through acquisition because things happen with such speed in these industries, acquisition is often more efficient and economical than building from scratch.

Third, the author writes "Regulatory risks are increasing, and difficult to price…."

There is no question that this concern is very relevant and should be watched closely by the investment community. Regulating these companies would be very difficult just because of the economics of their construction.

As mentioned above, these "new" Modern Corporations are constructed around networks that have substantial scale economies. They are not built, like the conglomerate, around portfolios of independent companies.

Not only would attempts to regulate segments, let alone break them apart, destroy the model of the network, it would destroy all reason for the "new" Modern Corporation to exist. We must move in this direction…if we are to move in this direction…very carefully.

This is a new economic model. Consequently, we must learn a lot more about it before we really start to tamper with it and try to change it. However, this does not always stop politicians.

For the time being, the writer for the Financial Times concludes, "The biggest takeaway from the FAANGs' latest results is that their businesses remain, fundamentally, in pretty good shape."

I concur with this conclusion, but it still doesn't the fact that we need to understand the importance of this sector in the behavior of the stock market. Through most of the current economic recovery, the actions of the Federal Reserve System tended to underwrite the almost constant rise of stock prices. In many cases the rising stock market was supported by two sectors, consumer goods and consumer services. That is not the case anymore.

We are now in a new phase or monetary policy. In the near future, the stock market will not be moving in "lock step" with the Fed as it has over the past nine years or so. As a consequence, major sectors, like "technology" may play a much bigger role in overall movements in the stock market than they have. We need to understand this in constructing our stock portfolios.

Analyst’s 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.