Can the leading crypto outshine large-cap tech names?

Key Takeaways

  • Shares of FAANG underperformed the S&P 500 and Information Technology Sector, high valuation could be a setback.
  • Regulatory challenges and the shifting consumer habit cloud FAANG’s growth outlook.
  • Bitcoin’s decentralized nature could be an alternative hedge of social-centric tech companies.

Overview

Despite the fluctuations in the equities markets, major US stock indexes are still able to maintain its YTD gains so far, sectors such as tech and real estate have been contributing most of the gains to the indexes. As regulatory issues are continuing to loom the outlook of those fast-growing sectors, could bitcoin make a better investment in a volatile market compared to the mega-size tech companies?

FAANG Underperforms

Although the tech sector has been a major pillar supporting the US equities markets, 2Q19 was a terrible quarter for the tech sector, the NYSE FANG+ Index, which measures the performances of 10 largest US-listed tech and media companies with the biggest market cap, such as Facebook, Apple, and Amazon. The Index has given up more than 18% of the market value in May before rebounding in June and July. However, the FANG+ Index is still underperforming the broader S&P 500 and the S&P Information Technology sector. FANG+ has gained about 11% year to date, while the S&P 500 has up more than 14% in the same period, meanwhile the S&P Information Technology Sector Index rose 25%.

Figure 1: FAANG + Underperforms

Source: tradingview.com

Overvalued?

So, after the selloff in May and early August, are tech giants still overvalued? Before answering that question, it’s key to understand the growth outlook of those companies. Figure 2 shows some of the key ratios of major tech companies. From a P/E ratio perspective, many of them were trading at a premium when the S&P IT Index P/E was only at 26.72.

According to the data below, some companies’ forward P/E ratios were lower than the trailing P/E ratios, such as Facebook and Alibaba, which indicates they are probably not fast-growing. Generally, a company with a higher forward P/E ratio than the industry or market average indicates an expectation of the company is likely to experience a significant amount of growth. However, if the company fails to meet the high growth demand with increased EPS, the price of the stock will likely fall.

Additionally, the PEG ratios may give you a more complete picture in terms of growth expectation. While Twitter may seem to be the cheapest at the PEG ratio of 0.71, the underlying assumption of 23% growth may not be sustainable. On the other hand, Nvidia may outperform its 9.5% growth rate, yet, a company with a PEG over 1.0 is often considered overvalued.

Figure 2: Tech Giants’ Valuations

Source: Morningstar; Zacks

Goldman Sachs has already sounded the alarm of the high-growth tech stocks. In June, David Kostin, Goldman’s Chief US Equity Strategist, notedhis clients saying, “Rising market concentration and the political landscape suggest that regulatory risk will persist and could eventually weigh on tech company fundamentals.” Kostin also added that “The valuation premium for growth is elevated relative to history; Software in particular now carries the highest multiples since the Tech Bubble.”

Regulatory Challenges

The rapid expansion of the tech sector has caught regulators’ eye, and this scrutiny could be a major hurdle of the price performance of major tech stocks.

Just recently, the US Justice Department confirmed that it’s working with state attorneys general to investigate whether tech conglomerates like Facebook and Google were involved in stifling competition practices. Makan Delrahim, Assistant Attorney General for the Antitrust Division at the DoJ said, “We just have to have proper, timely and aggressive enforcement of the antitrust laws.”

DoJ is reportedly has launched an antitrust investigation against Google and other major tech platforms. The Wall Street Journal suggests that the investigation would focus on how the tech giants have grown their ranks and expanded their reach into the businesses, also how they’re leveraging their massive user bases. Markets expected the probe could potentially lead to more focused inquiries into specific issues, as well as expand to include unrelated legal violations that arise during the antitrust probe.

“We just have to have proper, timely and aggressive enforcement of the antitrust laws.”

Makan Delrahim, Antitrust Division, DoJ

Out of Fashion?

In many cases, the social platform is an important component of these tech conglomerates, when considering their growth outlook, it’s key to factor in the platform’s favorability among different user segments, and a recent report suggests that Millennials are no longer a fan of social media.

Financial services company INTL FCStone released a report in July, saying the high-flying tech names like Facebook, Amazon, Apple, Netflix, and Alphabet are all showing signs of slowing growth. Millennials once were the major driving force behind the strong growth, now no longer the case. Vincent Deluard, Global Macro Strategist at INTL FCStone noted that, as millennials grow up, the generation seems no longer a strong trendsetter as they were before, and marketers have already shifted their attention to younger, more attractive Generation Z.

Although Gen Z appears to be a market with huge potential for tech companies, many studies have found out that social media are losing its grip on young people, which could jeopardize the growth of some major tech companies.

Figure 3: Facebook, Amazon, Apple, Netflix, and Alphabet performances since 2017

Source: tradingview.com

Bitcoin: A Tech Alternative?

As FAANG’s appeal fades, could bitcoin be a better tech alternative? Bitcoin has often been considered as a bubble that could burst anytime. Think about FAANG stocks, the total market cap of the top 5 tech stocks has reached over $3.1 trillion as of late August 2019, and figure 4 shows that the total crypto market cap now standing at around $246 billion, so from the market cap prescriptive, the two are not that different.

Figure 4: Total Crypto Market Capitalization

Source: Coinmarketcap

Despite the lukewarm performance of the FANG+ Index, the market cap of the leading tech companies still inflated. Figure 5 shows that the FANG+ Index has gained about 10% YTD, while the prices of bitcoin and the total crypto market cap have a triple-digit growth in the same period, still the magnitude of FAANG remained significantly larger than the whole crypto space, so from this prescriptive, apparently tech stocks are more bubble-liked than crypto overall.

Figure 5: Returns of FANG+ Index vs. Total Crypto Market Cap vs. BTCUSD (YTD)

Source: tradingview.com

Figure 6: FANG+ Index vs. Bitcoin (YTD)

Source: tradingview.com

Decentralized at Heart

As we discussed before, the social element is one of the most crucial parts in many tech companies, in cases like Facebook, it’s the major operating business of the firm. However, in some sense, the way tech companies run their social platforms, is a business model of decentralization.

Take Facebook, for example, Facebook users are not customers of the social platform, they are the products. From the company’s prescriptive, Facebook is a decentralized platform that owns a diversified source of content, so that the firm does not have to rely on a single source of content, therefore reduced the risks.

Bitcoin, in a certain way, works the same. Bitcoin is a decentralized platform for payments and store of value, and the value of bitcoin is very largely determined by its users. So, on that front, bitcoin and social media seem to share the same underlying value.

Conclusion

We’ve reviewed the challenges that major tech companies are facing, such as regulatory issues and the change in consumer habits. Valuation-wise, FAANG seems to remain at a relatively high level and its sustainability remained in question. However, bitcoin could provide a better alternative for growth-seeking investors, its decentralized nature appears to be a decent substitute for the high-flying tech stocks. While there’s yet no sign of the urgency of selling the tech stocks, but bitcoin could be an ideal hedge of a tech-centric investment portfolio.


Disclaimer: This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involves significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.


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