5 Takeaways from the DeFAANGed War Room

For years, investing in the tech giants has felt like a sure thing.

Recently, though, something unnerving has been happening with tech mega-cap stocks. It seems the FAANG dynasty may be over, with Meta (née Facebook), Netflix and Amazon experiencing a precipitous drop following a lift in the early pandemic. And while the IT giants–Apple, Alphabet (née Google) and Microsoft–are slower to contract, they too seem to be on a downward trajectory.

With the FAANGs constituting nearly a quarter of the S&P 500 at their height, what does this contraction mean for the market? That’s the question we explored in April’s War Room. Here are the top five takeaways from our full discussion.

1. Tech can help the Fed achieve a negative wealth effect.

Inflation remains a problem, and to turn that around, the Fed needs to drive the system toward negative wealth.

The most immediate way to do that isn’t through rate hikes; it’s by taking down the FAANGs. Powell’s talk about aggressive rate hikes may not come to fruition, but it can potentially accomplish its aim of slowing inflation simply by scaring investors out of the market.

2. The tech sector is no longer moving in tandem.

It used to be that wherever the FAANGs went, so too did the rest of the tech market. Those days appear to be coming to an end.

The FAANG gang has split up, with the businesses that rely on subscriptions–namely Netflix and Meta–taking a sharp dive, while those with some more cash in reserves–like Amazon and Alphabet–are holding steadier.

There are also some alternative tech bright spots emerging in the market. Companies in the cybersecurity space, for example, are experiencing growth that runs directly counter to what’s happening with the tech mega-caps.

3. Index funds are overexposed to tech and underexposed to the real economy.

Because the tech darlings have been a safe bet for so long, many ETFs and index funds have taken outsized positions in tech to provide juiced-up returns for investors.

That strategy is now coming back to bite them. As the FAANGs head rapidly downward, they’re taking many index funds down with them.

But this steep downturn isn’t indicative of what’s happening in the broader economy. Energy, for example, has balanced out despite the disturbances created by the Russian invasion of Ukraine. The rest of the economy is doing okay, but many portfolios are unnecessarily suffering because they’re overweighted with big tech buys.

4. Now is the time for hands-on investing.

Robo-advisors are an easy and cheap way for new investors to enter the market, but they often rely on index funds to keep costs low and exposure distributed. The problem now is that many index funds are overweighted with tech–so suddenly, the “cheap and easy” approach to investment is costing people.

Now more than ever, the market is demonstrating the value of working with an advisor. With tools to stress test portfolios and measure risk, the advisors who are around to guide clients through this rocky time are the ones that come out on top.

5. The good, the baseline and the ugly.

We end each War Room by looking at potential outcomes for the scenario in question. Here’s what we see as the good, baseline and ugly for DeFAANGed.

In the good scenario, tech Darwinism comes to an end, replaced by real secular growth stories. Apple, Microsoft and Alphabet experience a short-lived washout, while tech bright spots–like cybersecurity–shine through.

In the baseline scenario, the bifurcation trend continues. The FAANGs remain in a bear market for the next year, and other tech stocks follow suit. As rates rise, this scenario will expose who’s really insulated and who’s been left out to dry.

In the ugly scenario, these overexposed index funds fall apart. With a record concentration of indexes in only five big names, and hardly any exposure to energy and the rest of the real economy, this pain continues for those who have relied on robo-advisors and passive management.

No matter where on the scenario spectrum we actually land, this situation should serve as a cautionary tale to investors. If you’re not working with an active management partner, you could be putting yourself at financial risk. Advisors who are watching market trends and adjusting your portfolio accordingly are the ones who have the greatest potential of insulating losses and picking up gains–no matter what the rest of the market is doing.

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