Alpesh Patel on US Investing: Time to Ditch the FAANGs? What About Small Caps?

fangs

The FAANGs — the name given to five of the best performing tech stocks, Facebook, Apple, Amazon, Netflix, and Google (now called Alphabet) — have produced fantastic returns for years. However, regulatory headwinds and a reopening economy have led some analysts to sound a note of caution. Is it time to ditch the Faangs?

Over the last decade, the FAANGs have become investors favourites because of their consistent strong returns. In fact, they have been one of the primary reasons why the S&P 500 produced returns of almost 300% during that period.

Why the FAANGs Could Stop Growing

However, some analysts, like Mike Bell, global market strategist at JP Morgan, believe these companies can’t continue to overperform. Bell thinks that Fed tapers and rising bond yields will favour value stocks by the end of the year. He goes on to add that these conditions traditionally help financials and small-caps.

While it is tempting to listen to contrarian investors, it seems that there is plenty of steam left in the big tech companies. To put it all in context, the FAANGs are still driving the Nasdaq 100. Last financial year, they provided one-third of the Nasdaq’s return. Indeed, they strongly outperformed that particular index, with many other major indices success hinging on how many FAANGs they had.

Alphabet’s Massive Q2

Alphabet’s earnings in the last quarter exceeded the expectations of many. Revenues of $55.3 billion, which were up 34% year over year, have led to an 11% increase from the last quarter. However, with GOOGL already operating in all global markets, sectors and industries, some investors are wondering what room is left for them to grow?

For many, worries about the FAANGs come down to continued market dominance. However, Google’s search engine has few competitors, while the iPhone holds a considerable segment of the smartphone industry. Additionally, Amazon and Facebook show little sign of slowing down.

Potential Areas of Growth

Considering these companies’ appetite for innovation, the growth areas for the companies could come from unexpected places. Google CEO Sundar Pichai has identified Google Cloud as a huge avenue of growth, for example.

Conclusion

The FAANGs strong growth over the last decade has led to market dominance. Although some feel that the pace of returns can’t continue. The Joe Biden administration has tech stocks in its regulatory crosshairs, and rising bond yields and Fed tapers could result in good conditions that support value stocks.

However, the FAANG stocks excellent earnings and constant innovation mean that they still have a lot left in the tank.

What about Small Caps or other Large Caps?

Small-Cap or Large-Cap Stocks: The Case for Both

A year on from the US lockdown, the economic recovery is well on its way. Vaccine rollout has been a success, and government stimulus packages have held up the economy. For a long time, this recovery was slightly uneven and favoured large-cap stocks. However, this has begun to change.

Let’s look at how small-cap and large-cap stocks are performing and figure out which size company offers the best value for the future.

Small-Cap Optimism

Thanks to a return to more typical economic conditions, there is a lot of optimism in the air among investors and business owners. Small-cap firms, in particular, will welcome the recovery. Typically, they are more sensitive to economic conditions.

Small-cap growth stocks shot up 16.5% during the first half of 2021. Additionally, small-cap value stocks have risen 30.6% in the same period. On top of this, the S&P SmallCap 600 index has grown by 23.6%. These returns have outpaced the mid-and large-cap indices — S&P MidCap 400 (17.6%), and S&P 500 (15.3%)

These represent fantastic performance for the type of investor who has the grit (and the patience) to endure the short-term volatility and risk inherent in small-cap stocks. Indeed, for those who can wait, there is considerable potential for solid long-term gains.

Will Market Leadership Shift?

Over the last three or so months, the ongoing narrative has favoured large-caps stocks. Indeed, the current risk-adjusted rankings for US-style indexes (based on Canterbury’s Volatility-Weighted-Relative-Strength) has supported large-cap firms. The performance hierarchy has been: Large-cap, mid-cap, small-cap.

This pattern has repeated itself across the S&P 500, with the biggest securities outperforming the overall market. For example, the S&P 500 is up 8% overall. However, in the same period, the Tech sector has grown 16.5%, while Communications, Discretionary, and Healthcare are around 10%. These sectors are responsible for roughly two-thirds of market growth.

Aside from Real Estate, none of the other seven sectors has grown more than 5% over the last three months. It’s clear that smaller sectors are beating the market.

But in recent weeks, a different picture is emerging. Utilities, Financials, and Consumer staples have started to outperform, suggesting that there could be some shift in market leadership.

As August began, Utilities and Consumer staples were the 10th and 6th best-performing sectors. However, Utilities have shot up to #4, while Consumer stapes are at #3. Could this herald greater participation of different types of securities in the market as the economy bounces back?

What Small-Cap Stocks Looking Strong?

If small-cap stocks are on the rise, which represents the best options?

According to their relative number of hedge fund owners, three stocks are looking promising:

  • Hostess Brands, Inc, a leading American packaged food company,
  • Turning Point Brands, Inc. an American tobacco manufacture
  • Bloomin’ Brands, Inc. American restaurant holding company

Another area full of potential is to be found in the Alternative Investment Markets (AIM). Investors Chronicle recently published its recommendations and found 30 AIM stocks that passed its screening methods. They’ve highlighted Boohoo and Asos as two fashion stocks that performed well on their rating.

How Will Large-Cap Stocks Perform?

Large-cap stocks S&P 500 performance has been primarily driven by tech stocks. Overall, large-caps have outperformed other stocks, but if the FAANGs slow down, what would the picture look like?

If you take out Facebook, Apple, Amazon, Netflix, Google, and also Microsoft, the S&P 500 looks a little less rosy. In fact, the equal-weight S&P 500 has been drifting sideways for the last few months. A distinct picture is emerging: Cap-weighted S&P 500 is being driven by tech stocks, with Healthcare and Real Estate also performing well.

What Mutual Funds are Worth Looking At?

Of course, despite the optimism around small caps, large caps still have a place in any investor’s portfolio. There are some exciting options to consider for anyone looking to enter the market via mutual funds focused on mid or large-cap firms.

Large-cap mutual fund Canara Robeco Bluechip Equity Fund has posted 5-year returns of 17.98%. The Axis Bluechip Fund (18.27%) and the Mirae Asset Large Cap Fund (16.92%) are other strong performers.

Mid-cap mutuals could be an option for investors looking for slightly higher returns (with slightly higher risk). PGIM India Midcap Opportunities Fund has returned 22% over five years, while Axis Midcap Fund (21%) and Quant Mid Cap Fund (20.96%) aren’t far behind.

Alpesh Patel OBE

This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.


2 comments on Alpesh Patel on US Investing: Time to Ditch the FAANGs? What About Small Caps?

  1. It is generally, never a case of “ditching” quality! It is more so that if the market should fall, like it did at time of the pandemic, then its an opportuntity to buy more quality. So what do you do when you have quality, but want additional growth, as the saying goes, “elephants dont jump” – well you employ a strategy that employs a top down approach, which meet metrics and have a higher propensity to grow, which then generates profit, which you bag, and then can be put to use when the market drops to buy more FAANG stocks, AS LONG as the story is the same of course

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