Q1 2018 Recap

Last quarter’s two major topics involved trend reversals: a suddenly rocky stock market and a “de-FAANG-ing” of the tech sector.

Return of Volatility

We spent much of last newsletter discussing the unusual tranquility of 2017’s markets. So far, 2018 has been much rockier.

volatility.png

Last quarter saw two rise-and-fall mini-cycles. It also produced the first market correction (10% drop) since February 2016. After registering historical lows in 2017, VIX, a measure of market volatility, roared back to life.

A variety of culprits have been proposed: signs of renewed inflation, fears over tariffs and trade wars, and troubles in the technology sector.

However, the more interesting tide change is not the new narratives. It’s that narratives are affecting the market at all.

There was no shortage of news last year – rising rates, tax reform, geopolitical turmoil. Yet the markets barely budged, just steadily ticking upwards.

It’s anyone’s guess why investors turned sensitive this year. Most indicators still signal broad economic strength.

economics.png

Paradoxically, that strength may be behind some of the Q1 volatility. Investors may be considering whether the market is too strong.

We are nine years into an economic expansion. Many economists are wondering how much upside is left. The coming quarters may be similarly volatile as the market responds to signs, however slight and potentially imagined, that good times are nearing an end.

De-FAANG-ed

Technology stocks, particularly “FAANG” – Facebook, Amazon, Apple, Netflix, and Google – led the jump in market volatility.

Front page news contributed to tech’s bumpy quarter. Facebook’s data leakage may result in user loss and regulation. President Trump repeatedly called out Amazon for perceived unfair practices. A trade skirmish with China could harm Apple, which builds its products and earns 20% of its revenues in China.

FAANG’s declines were staggering in absolute terms. The companies lost $280 billion in value in just the last two weeks of March. However, in relative terms, the Q1 declines are merely a small step back (see table on next page).

faang2.png

Tech has grown so powerful that, like Icarus, it may fly too close to the sun. FAANG’s $2.9 trillion combined value is a tenth of the U.S. stock market and larger than every country’s market, except for Japan, the United Kingdom, and China. Nearly $2 trillion of that value amassed since Facebook’s May 2012 IPO.

Lest anyone use Q1 to draw parallels to the Dot-Com era, realize how far tech has come the past couple decades. It now generates profits in line with its size. 

tech.png

In October’s newsletter, we relayed an analogy told to us by a Capital Group Senior Portfolio Manager: what killed the biggest, baddest dinosaurs? Not another dinosaur, but a comet. His point is that the main threat to today’s big tech company may not be disruption from another company, but unforeseen regulation. Tech’s scale may invite greater future scrutiny from citizens and governments, here and abroad.

FAANG are hugely profitable, global companies. It is hard to imagine normal economic forces will dethrone any in the near future. Whether Q1 signals a tipping point that unleashes abnormal forces will be fascinating to watch.