Mega cap Tech (FAAMNG+TSLA) has rallied to start 2024 with contributing roughly 80% of the S&P 1.5% YTD return. Tech is not Defensive explicitly but returns to Size and Low Vol have become correlated. Put simply, aggressive rotations into Tech coincide with large positive swings in Low Vol stocks and weakness in unprofitable Tech.
Investors favored large cap and risk-off names during 2023 in part due to heightened recession risks. A soft landing is increasingly an accepted base case but concerns about slower growth AND fewer rate cuts have led to another round of risk-off outperformance recently. Price Momentum has also contributed to mega cap excess returns this year. Mega caps are heavily exposed to Price Mo, which is positively correlated with Low Volatility returns.
At the macro level, the returns of Mega caps are harder to understand today. Since early last year, the spread between the Mega/Unprofitable relative return and high yield spreads has widened to all new highs. a similar pattern has played out between mega cap and profitable Tech. The relative performances of top 10 market cap Tech names vs. profitable tech has surged this year. If concerns about growth and rate cuts ease profitable non-Mega cap Tech should benefit.
All of the above is not to say there is not a fundamental story for Mega cap Tech. Rolling 1 year NTM EPS growth for mega Tech is 37% versus the S&P’s 1.5% (ex-megas). Strong E for Megas has resulted in the group having a MUCH higher average PE than the market, skewing overall valuation. Excluding mega cap Tech names would push the S&P NTM PE from 20.1 to 17.8x
There has been an important shift in the exposure of Mega Tech to Growth though. Two years ago, Mega Tech was high Realized Growth – growth rates of sales, cash flow, earnings. Today, the Realized Growth exposure of the group has fallen. To be clear, these are still massively profitable companies. The point is that the amount of Realized Growth in other parts of the market is catching up.
Risk-off Mega Cap Rotation: Mega cap Tech (FAAMNG+TSLA) has rallied to start 2024 with contributing roughly 80% of the S&P 1.5% YTD return. Ex Mega caps, the S&P is up 0.4% this year. Zooming out, over the past 6mos, mega caps have been responsible for more than 40% of index gains (44th %tile). Over the past year that number is 60% (95th %tile). Tech is not Defensive explicitly but returns to Size and Low Vol have become correlated. Put simply, aggressive rotations into Tech coincide with large positive swings in Low Vol stocks and weakness in unprofitable Tech.
That is not to say there is not a fundamental story for Mega cap Tech. Rolling 1 year NTM EPS growth for mega Tech is 37% versus the S&P’s 1.5% (ex-megas). Strong E for Megas has resulted in the group having a MUCH higher average PE than the market, skewing overall valuation. Excluding mega cap Tech names would push the S&P NTM PE from 20.1 to 17.8x.
Investors favored large cap and risk-off names during 2023 in part due to heightened recession risks. A soft landing is increasingly an accepted base case but concerns about slower growth AND fewer rate cuts have led to another round of risk-off outperformance recently. Price Momentum has also contributed to mega cap excess returns this year. Mega caps are heavily exposed to Price Mo, which is positively correlated with Low Volatility returns.
Overall, mega caps are most exposed to Momentum, Quality, and Earnings Growth. Those exposure are contributing to its returns this year. There has been an important shift in the exposure of Mega Tech to Growth. Two years ago, Mega Tech was high Realized Growth – growth rates of sales, cash flow, earnings. Today, the Realized Growth exposure of the group has fallen. To be clear, these are still massively profitable companies. The point is that the amount of Realized Growth in other parts of the market have caught up.
At the macro level, the returns of Mega caps are harder to understand today as well. Mega caps lack of credit risk made them attractive last year as financial conditions tightened/spreads widened. Historically, Mega caps outperform unprofitable Tech when spreads widen. Since early last year, the spread between the Mega/Unprofitable relative return and high yield spreads has widened to all new highs. There isn’t a level to level mapping of Mega/Unprofitable Tech and spreads that is clear to us. But the wide spread between the two groups suggests there is value in screening for unprofitable Tech names that are sensitive to declining high yield spreads.
Unprofitable names are inherently risky and tend to underperform. But a similar pattern has played out between mega cap and profitable Tech. The relative performances of top 10 market cap Tech names vs. profitable tech has surged this year. If concerns about growth and rate cuts ease profitable non-Mega cap Tech should benefit.
