ACG Insights: A Tale of Two Markets Executive Summary Since CNBC’s Jim Cramer coined the term “FANG” stocks back in 2013, these stocks have become the darlings of the market and focus of much attention due to their dominant market positions, strong earnings growth and relative outperformance vs. the broad market (Exhibit 1) The five largest stocks in the S&P 500 Index (Facebook, Amazon, Apple, Microsoft and Google) are now 22% of market capitalization and responsible for 15% of earnings (Exhibit 2) Year-to-date 2020 performance has been bifurcated between these 5 stocks in the S&P 500 Index and the other 495 stocks (Exhibit 3) The total market capitalization of those five stocks (plus Netflix…which is often included as part of the “FANG” moniker) now exceeds the total market value of the Canadian and major European equity markets (Exhibit 4) The valuation, on a price-to-earnings basis, of the top 5 stocks is also much higher than the other 495 stocks in the S&P 500 with a P/E ratio multiple 13x higher than the other stocks (Exhibit 5) Background Much has been written and talked about in regard to concentration in today’s market. Growth and technology stocks have led the market rally over the last few years with particularly strong outperformance over the last year. In 2013, CNBC’s Jim Cramer coined the term “FANG” stocks to signify the four names (Facebook, Amazon, Netflix and Google) that had become increasingly dominant in their market position and performance. Some years later, the definition was changed slightly to “FAANG” to include Apple. More recently, Microsoft was also added to the grouping due to its increasing size and positioning within the technology sector. Regardless of the actual constituents, in spirit the acronym now broadly represents those largest technology related stocks that have become market leaders. As you can see, their performance has been impressive – with the NYSE FANG+ index increasing almost five-fold over the last five years (Exhibit 1). 309 East Paces Ferry Road, Suite 600 | Atlanta, GA 30305 | T 888.317.2810 | F 470.823.3178 | theatlantaconsultinggroup.com 1 August 2020 Exhibit 1: “FANG” Stock Performance 1 Coincidently, as these stocks have outperformed, their market capitalizations have increased significantly. Currently, the largest five names in the S&P 500 Index, by market capitalization, are Facebook, Amazon, Apple, Microsoft and Google. These five stocks now make up 22% of the total market capitalization of the S&P 500, and they are responsible for 15% of the total earnings of the index (Exhibit 2). The five names now represent approximately $5 trillion in market capitalization. Apple alone has a market capitalization of just under $2 trillion (which may be eclipsed by the time you are reading this). In one day during late July 2020, these stocks added over $200 billion to their market values! Exhibit 2: Top 5 Stocks (% of Market Capitalization & Earnings) 2 1 Source: Bloomberg FANG+ Index. The NYSE FANG+ Index is an equal-dollar weighted index designed to represent a segment of the technology and consumer discretionary sectors consisting of highly-traded growth stocks of technology related companies. 2 Source: Goldman Sachs 309 East Paces Ferry Road, Suite 600 | Atlanta, GA 30305 | T 888.317.2810 | F 470.823.3178 | theatlantaconsultinggroup.com 2 August 2020 Year-to-date 2020 returns Average investors and Wall Street equity strategists alike have been surprised at the speed and magnitude of the recovery in equity markets following the pandemic induced sell-off during the first quarter of 2020. But, if you look a little deeper at the individual constituents responsible for such a swift recovery you can see that the return of the S&P 500 Index has largely been driven by the largest 5 stocks. Facebook, Amazon, Apple, Microsoft and Google are up a combined 35% year-to-date while the remaining 495 stocks are in negative territory over the same period (Exhibit 3). This dispersion highlights the “haves and have nots” that characterize market movers in 2020. Obviously, the post COVID-19 world favors many of these companies based on an increased number of remote workers, a general uptick in the use of social media, and an increase in e-commerce associated with many of the social distance regulations aimed at slowing the spread of the Coronavirus. It remains to be seen how many of these trends will be enduring, but the market clearly thinks the trends will continue based on the performance of these stocks. Exhibit 3: Year-to-Date Performance 3 What does $5 trillion buy these days? As mentioned previously, the five largest stocks now represent approximately $5 trillion in market capitalization. When we discuss trillions, or even billions of dollars, the ability to conceptualize what these large sums represent can be difficult. For example, the U.S. Federal budget for 2019 included $4.4 trillion in spending. Total government revenues, by comparison, were $3.5 trillion. Even if you go back just five years and look at the same statistic of the market capitalization of the top 5 stocks, you get a much smaller number, $2.0 trillion. Another way to view this concentration and what it means in terms of the total value of these companies is to compare the value of the top 5 stocks plus Netflix to other world stock markets (Exhibit 4). You can see that the current value of these few stocks now eclipses the total market capitalization of the Canadian and major European markets (including France, Germany, Great Britain, Italy and Spain) in their entirety! 3 Source: Goldman Sachs, Factset. Note: performance indexed to 100 at January 1, 2020 309 East Paces Ferry Road, Suite 600 | Atlanta, GA 30305 | T 888.317.2810 | F 470.823.3178 | theatlantaconsultinggroup.com 3 August 2020 Exhibit 4: Market Capitalization Comparison 4 Priced for perfection? These top 5 stocks, which have been rewarded for their strong earnings growth relative to the rest of the market, now trade at 31x their 2021 earnings estimates. The other 495 stocks in the S&P 500 index trade at a much more pedestrian 18x 2021 earnings. Both multiples are elevated vs. their own history and particularly so if you remove the data surrounding the bubble period of the late 1990s (Exhibit 5). Exhibit 5: Price / Earnings Ratio (2021 Earnings) 5 4 Source: Bloomberg 5 Source: Goldman Sachs, Factset 309 East Paces Ferry Road, Suite 600 | Atlanta, GA 30305 | T 888.317.2810 | F 470.823.3178 | theatlantaconsultinggroup.com 4 August 2020 Summary In addition to the many risks posed by the global pandemic and associated questions around economic recovery and future earnings, the market’s concentration in the largest stocks is now at a level above what we have seen historically. This concentration has made it very difficult for active managers in the large cap space. In particular, large cap growth managers who are benchmarked to the Russell 1000 Growth Index (where these stocks have a large weighting) have to decide whether they want to be underweight such large index constituents. As you can see from the performance in the prior exhibits, any relative underweights over the last five years have been a large detractor from relative performance. Many pundits also liken the current period to the Nifty Fifty period of the late 1960s and 1970s when a subset of large growth stocks captured investor attention and drove market returns to a large degree. While the Nifty Fifty propelled much of the market gains of the 1970s, they also crashed in the early 1980s and caused a broader market decline. What happens from here is so far unwritten, but we all need to keep an eye on the valuations and expectations of this increasingly large part of the equity market. Disclosure Investing is subject to a high degree of investment risk, including the possible loss of the entire amount of an investment. You should carefully read and review all information provided by The Atlanta Consulting Group Advisors, LLC (“ACG”), including ACG’s Form ADV, Part 2A brochure and all supplements thereto, before making an investment. The information contained herein reflects the opinions and projections of the ACG as of the date of publication, which are subject to change without notice at any time subsequent to the date of issue. All information provided is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. You should not treat these materials as advice in relation to legal, taxation, or investment matters. Various indices, including, but not limited to the S&P 500 Index, the FTSE 3-Month Treasury Bill Index, and the Russell 2000 index (each, an “Index”) are unmanaged indices of securities that are used as general measures of market performance, and their performance is not reflective of the performance of any specific investment. The Index comparisons are provided for informational purposes only and should not be used as the basis for making an investment decision. Statements herein that reflect projections or expectations of future financial or economic performance of the Fund are forward-looking statements. Such “forward-looking” statements are based on various assumptions, which assumptions may not prove to be correct. Accordingly, there can be no assurance that such assumptions and statements will accurately predict future events or ACG’s actual performance. No representation or warranty can be given that the estimates, opinions or assumptions made herein will prove to be accurate.