Investment Matters

When a "crash" is not a crash

Press headlines are often an inspiration for Investment Matters.  This week is no exception.

‘Tech crash’ and the like were the headlines over our long weekend, based on US Friday trading.   Contrary to what some of the headlines may have implied, what happened over last weekend was nothing like the dotcom market crash in the early 2000’s.

There are a number of random observations from this week’s ‘tech crash’.

What happened?

The NASDAQ index (US’s technology focused index) fell 1.8% in trading last Friday US time (our Saturday).

This is in a bigger context of the NASDAQ being up 15.1% CYTD and 27.9% FYTD.   The NASDAQ was, until the recent slight dip, at record highs.

The notable drivers of the fall were:

 

Share price movement

9-Jun-17*

Apple

-3.9%

Alphabet (Google)

-3.4%

Microsoft

-2.3%

Amazon              

-3.2%

Facebook

-3.3%

* Source: Yahoo Finance.

 

1. That’s not a crash

A ‘crash’ in a market sense implies a 20%+ fall in share prices.  These don’t occur very often  – dotcom crash (the tech bubble burst in the early 2000 when the US NASDAQ fell 77% peak to trough with other markets also impacted), and GFC would fit the bill.   A correction is more common, and usually means a movement in the vicinity of -10%.

The movements we have seen from Amazon, Apple et al don’t really even fit in to the correction category.

2.  Indexes aren’t perfect

The NASDAQ index is dominated by the 5 big tech companies – they comprise over 40% of the index.

Therefore, their share price movements have a large impact on the index – both positive and negative.  As seen by the graph below, they have had considerable share price appreciation over the last year (both calendar and financial). 

NASDAQ graph

Thus reading the index as a reflection of the health of the overall US economy, or even the tech sector generally, would be a flawed proposition.

Interestingly, their combined size means they also comprise around 13% of the broad-based S&P500 index.  Given their strong share price gains over the last year, they have been one of the driving factors behind the S&P500’s current record high.

In relation to the limitations / distortions that large weight positions can create in an index – there is a similar phenomenon in Australia, with the index weights of the big 4 banks in the ASX200 and All Ordinaries indices.

3. High priced stocks can correct

The P/E ratios of the 5 tech stocks in question are quite elevated, especially Amazon.   This partly reflects the expected growth in earnings years beyond the next financial year (prospective P/E only considers earnings one year ahead). 

It also often reflects "market darling" status -  companies that attract a premium because of their brand recognition, perception of being lower risk, or other such factors.  But buyer beware on market darlings – they may not retain their status forever (e.g. Blackmores).

 

Prospective P/E*

Apple

16.42

Alphabet (Google)

28.61

Microsoft

23.32

Amazon              

145.09

Facebook

30.88

* Source: Thomson Reuters, as at COT 14-Jun-17.

 

4.  Sell-off based on nothing

The sell down of the big name tech stocks didn’t seem to be based on a fundamental change, regulatory change, change in operating conditions etc – changes that would ultimately impact companies earnings. 

There is some commentary that a Goldman Sachs report highlighting the recent share price rally (particularly of the big 5 tech companies), and the associated risks, triggered the fall.

These sorts of movements, the lack of a fundamental driver of the falls, and the associated reactions (e.g. in the media), perhaps show a level of fear in the market.  This is not surprising given the US market is trading on high multiples.

5.  Fewer and fewer true investors

One broker (JP Morgan) did note this week that perhaps only 10% of trades are instigated by active investors.   Remaining trades are ETFs, passive funds, and programmed trades.   (This is US data, but Australia likely has a similar pattern.)

Specific data in relation to the nature of trades is very hard to come by.  However, it seems that we should read less and less into short term movements, because of the increasing prevalence of this type of trading.

6.  You don’t own the market

This week’s ‘tech crash’ headlines are, we consider, not reflective of the bigger picture, or even accurate.  If you did see these headlines, we would note that the read through to your own portfolio is negligible.

In the short term, some (but not all as we have seen this week) market jitters or jumps can filter through to movements in the share prices of companies you own.  However, over time, how each company in your portfolio performs and grows its earnings will determine their respective share prices.