Trading Desk: Big Tech Has Become The Problem

Remember when the FANG and its friends were the only stocks anyone on Wall Street wanted to own? That logic pushed just six Big Tech companies into the stratosphere . . . but now gravity is dragging the giants down.

Tesla (TSLA) started the cycle of disappointment with its earnings last week. As I noted at the time, the numbers were pretty good. Unfortunately, the market wasn’t happy with hints that growth is getting close to hitting a wall.

And since then, the rest of the Big Six have reported their results. One way or another, most of them missed the mark. Even today’s rebound leaves the group as a whole underwater.

That’s not great for bloated index funds as well as individual investors who counted on FANG and Friends as an invulnerable trade that worked under all market conditions. These stocks are no longer the solution to all our needs.

As a group, they’re now part of the problem. If anything, their sheer size obscures the truly great things going on elsewhere in the market . . . the giants of tomorrow that investors need to be rotating into before it’s too late.

Do The Math

Imagine for a moment that the six biggest tech stocks were traded as a single size-weighted portfolio, with Apple (AAPL) and Microsoft (MSFT) on top, Alphabet (GOOG) and Amazon (AMZN) in the middle and “little” Meta (META) and Tesla (TSLA) rounding everything up.

Since TSLA reported on October 19, that portfolio is down 3% in the aggregate. Yes, gigantic AAPL saved the day with today’s 7.5% surge, but the disaster at META more than wiped out that gain . . . and then AMZN tipped the scales further in the bears’ direction.

I’ll talk about why the overall response was so bad later on. For now, I just want you to focus on the fact that these stocks collectively take up 25% of the S&P 500 and a full 45% of the NASDAQ. When that much of your portfolio is declining, the drag is palpable.

And yet here’s the thing: since October 19, the NASDAQ is up 4% and the S&P 500 is up 5.5%. The other stocks in the market are working hard enough to overcome Big Tech’s pain.

I did the math. Factor out the Big Six, and the NASDAQ “should” be up closer to 13% in the last 10 days. We should be cheering. On the whole, that side of Wall Street is actually doing extremely well.

And if you could build an S&P 500 portfolio that excludes the same six stocks, you’d be up about 11% in the last 10 days. That’s the gain the blue-chip benchmark statistically needs a whole year to deliver.

This is rally country. We just can’t see it with those giants clogging top-heavy portfolios and dragging the overall returns down.

Want additional validation? There aren’t any trillion-dollar giants on the small-cap Russell 2000 . . . and that index is up 7% since TSLA started the Big Tech earnings cycle, which tells me there’s a lot of life on that end of the market.

I’ll be talking about why small stocks are beautiful now in Orlando next Tuesday. I hope you can join us if you’re in Central Florida. The argument really boils down to Wall Street’s intuition that one way or another, the economic cycle that guided us over the last few decades is coming to an end now.

Waiting For The Next Wave

And investing is all about capturing the future. What we want is the next economic cycle . . . the companies that will lead the way into that future much as the Big Six collectively led us out of the early dot-com era into the world where we all live today.

Let me list the tickers again so you really get a sense of what these stocks have achieved: AAPL. MSFT. GOOG. AMZN. META. TSLA. Smartphones. The digital music revolution. The cloud. Search. YouTube. Electronic commerce. Social media. Battery cars.

Some of these companies are still expanding. Others seem to be grasping for easy solutions or gambling on moonshot ideas. But on the whole, they aren’t the future so much as they represent the present. They’re the status quo.

That makes them vulnerable to disruptive little companies with fire, hunger and vision. After all, that’s exactly what the Big Six did when they started. Every one of them destroyed whole industries and created new ones.

Remember land lines? Remember when every business needed to run its own server? Remember record and book stores? No giant can remain complacent without running the risk that they’ll join those once-thriving competitors in obscurity.

(And remember the “N” in “FANG,” Netflix (NFLX)? In a world crowded with streaming video channels, there’s a reason we don’t talk much about them any more. Let the giants beware.)

Somewhere on the NASDAQ right now, the companies that will change our lives again are waiting. Investors who focus on them have a much better chance of making real money in the decades ahead.

Otherwise, you’re just betting on the status quo. That’s a safe strategy . . . but if you’re paying more than status quo valuations for status quo companies, you’re paying too much.

One reason MSFT and GOOG were punished is that they’re still priced like growth stocks and the growth just doesn’t seem to be there any more.

AAPL is growing. TSLA is growing. META is going the wrong direction. And AMZN seems to have hit a wall.

META Meltdown

I think the real finger of blame has to be pointed at too much competition for a limited pool of ad dollars driving COVID-inflated revenue back down.
Think about it. GOOG is struggling to make sales targets. SNAP is struggling to make sales targets. They’re going to discount their inventory to lure each other’s clients to change platforms.

And META is fighting that competitive war with a demoralized staff and a decreasingly relevant platform. Just look at the numbers: ad impressions are up 17% from last year. Revenue is down 4%. Pricing has collapsed. I don’t see it getting better any time soon. It’s likely to get worse.

Meanwhile headcount is up 28% and costs are up 19%. Zuckerberg isn’t going to lay a lot of people off. The board can’t force him because of the way voting shares are set up.

GOOG was a flat out failure. Ad sales are slowing down. $2 billion in revenue we thought was coming simply didn’t materialize. YouTube is stagnating. Management is more interested in cutting costs than reaching for those “moonshot” growth projects.

That’s not what a growth company does. That’s a company that’s settling for becoming part of the status quo. It’s not going to gamble on fresh ideas. GOOG has come as far as it can.

MSFT was nominally a win. The company hit its targets last quarter but the cloud keeps slowing down. PC sales are stagnant. Office is OK (+10%) but we don’t live in 1999 any more . . . cloud is now 40% of the top line but 60% of the growth. This is where the future of the company is.

On that basis, it’s frustrating to see cloud growth hitting a wall a little faster than we hoped. It’s still growing fast but when you’re looking at a $200 billion annual run rate you need your big engine to be expanding a lot faster than 34% a year to keep the overall company moving forward.

This one’s a victim of the law of big numbers. MSFT needs the cloud to grow at least 25% a year to keep revenue moving up a good-but-not-great 10% . . . and it takes more than that to justify MSFT’s battleship reputation or massive valuation.

The stock trades at 25X earnings and we don’t expect earnings to expand more than 4% in the current year. Earnings actually went DOWN last quarter. You do the math.

Can The NASDAQ Fight The Drag?

AAPL remains a winner, but there’s only so much it can do. The rest of the Big Six still outweigh it by a factor of roughly 3 to 1. AMZN isn’t helping. GOOG isn’t helping. MSFT isn’t helping.
META looks more likely to drop to NFLX levels than recover any time soon. Evidently robbing the “FANG” of its “F” was bad luck for Zuckerberg and friends.

Three months from now, they’ll all get another shot at impressing Wall Street with numbers that demonstrate real tangible progress. As it is, I think the NASDAQ can recover 11,400 thanks to AAPL and the collective force of the smaller companies in the index . . . but it might struggle to give us more than 10-11% even in the best of all possible Santa rallies.

That’s going to leave the tech index in bear market territory. Avoid Big Tech. I’d rather be in the old-fashioned Dow right now.