After last week’s collapse in Facebook shares, Goldman’s clients are hardly happy: after all, Goldman – which has a Buy rating on the stock – not only upped its price target from $205 to $225 back on April 26, which it then promptly trimmed back to $205 after the biggest value destroying event in history, but at the start of June explicitly said there was no danger of a bubble forming in tech stocks for years. And it’s hardly only Goldman clients: as Goldman’s David Kostin writes in his latest Weekly Kickstart, “FB ranks at the top of our Hedge Fund VIP List, with 97 funds owning it as a top 10 portfolio position”…
… although in a curious move, the bank also notes that investors that did own FB and sold following its results “apparently rotated into other stocks rather than holding cash; on Thursday the S&P 500 excluding FB rose by 10 bp, seven of 11 sectors posted positive returns, and share prices of FB’s FANG peer GOOGL rose by 75.”
Yet while Goldman clients appear to have taken Facebook’s collapse in stride, they are expressing another growing worry namely the “bad breadth”, or increasingly more narrow leadership, of the market. We first noted this one month ago when we discussed that just the Top 4 stocks have been responsible for 84% of the S&P’s upside in the first half of the year.
First forward 4 weeks, when Goldman’s Kostin writes that the biggest concern expressed in client conversations has been the increasingly narrow breadth of the equity market in that “the top 10 contributors have accounted for 62% of the S&P 500 7% YTD return”, and this even after Facebook’s record plunge which also dragged down some of the other most prominent tech names.
Of these 10 stocks, nine are technology or internet firms. The Technology sector alone accounts for 56% of the S&P 500 YTD return (76% including Consumer Discretionary members AMZN and NFLX).
As a result, Goldman’s proprietary “Breadth Index” currently reads 0 out of 100.
Other, more conventional measures of market breadth also show a recent narrowing. The next chart shows the distance of the S&P 500 from its 52-week high with the corresponding distance for the median constituent: “when only a small number of stocks act to lift the broad index, that gap turns negative and signals narrow breadth.”
Think of this chart as the risk momentum behind market leadership names turns negative. Meanwhile, from a fundamental perspective, narrow market leadership typically reflects narrow earnings strength, which is often a symptom of a weakening operating environment. To be sure, there are several prominent examples of this occurring:
in addition to the well-known episode of narrow breadth during the Tech Bubble, previous narrow breadth markets occurred ahead of the recessions in 1990 and 2008 as well as the non-recessionary economic slowdowns of 2011 and 2016.
And yet, despite the increasingly narrow breadth, there is the silver lining is that from a historical perspective, “market breadth has not yet narrowed enough to signal investing danger.”
In the past, sharp declines in breadth have signaled below-average 1-, 3-, and 6-month returns for the S&P 500 as well as larger-than-average prospective drawdowns. Relative to history, however, the recent narrowing of market breadth has not been sharp enough to trigger alarm.
Which brings us to the second risk mentioned by Goldman’s clients: concentration.
Here the logic is similar to breadth, only instead focus is on market cap and earnings for the handful of market leaders, where the 10 largest firms now account for 23% of index market cap. As Kostin notes in the past, most instances of rising market cap concentration among a handful of stocks corresponded with an increase in earnings concentration as well, and cautions that “usually, these narrow bull markets eventually led to large drawdowns when investors lost confidence in the increasingly expensive handful of crowded market leaders.”
Here the saving grace is that whereas the Top 10 companies are now the most concentrated they have been since the financial crisis in terms of market cap, the continued earnings growth – which as we noted yesterday has so far seen a record number of stocks beat expectations – helps to stem fears:
Unlike past episodes of narrow market breadth, the earnings environment today appears healthy and broad-based. The top 10 S&P 500 stocks currently account for 20% of index earnings, roughly the same as in each of the last few years, and slightly below the 30-year average of 21%. In 2019, consensus expects the median S&P 500 stock to grow EPS by 10%, slightly faster than the 9% growth expected for the index.
Ok, but why in this time of strong profit growth is stock performance not distributed in a more even fashion? The answer, according to Goldman is due to investor concerns about global growth, including risks from trade conflict, which explains the “unusual current combination of strong fundamentals and narrow market breadth.” Meanwhile, elevated valuations discourage investors in many sectors.
Finally, the herding of most investors into a handful of stocks was the result of solid momentum and strong secular growth profiles of the largest market leaders have continued to attract investor assets. At least, that was the case before Facebook and Twitter both tumbled by 20% and have yet to see BTFDers emerge.
To Goldman, the irony of defending momentum-driven tech names while warning about potential “bad breadth” is not lost, and as Kostin observes, Facebook’s decline this week highlights the risk inherent in a narrow-breadth market, but instead of turning more cautious, the bank’s chief equity strategist writes that market performance in Facebook’s wake “supports our strategic preference for Technology and growth stocks.”
And so Goldman – whose prop desk may well be selling its tech exposure to marginal buyers – will continue to urge clients to be longs stocks until more such shock events take place,
For now, hedge funds believe the firm, and even after the Facebook fiasco, tech remains a hedge fund and mutual fund favorite, even though the latest 13-F filings showed that tilts in the sector are smaller now than they were in 2016 and 2017.
Goldman’s parting words to its “concerned clients” are of encouragement:
Other positioning data including our Sentiment Indicator suggest overall portfolio length has declined significantly in recent months, reducing concerns of crowding. While government policy remains a key risk, the pricing power of many Tech firms should help insulate them from the margin risks posed by escalating trade conflict.
In other words, “don’t worry not everyone is on the same side of the boat.” Perhaps, although after we beg to differ after just one look at this chart from Bank of America which shows that if one strips away tech and commerce, world stocks have barely moved this decade.
And if Facebook’s collapse showed one thing, it is just how flimsy the foundation supporting this sector has become, as investors panic sell first in some cases not even bothering to ask questions later…
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