Sinking Into FAANGs
January 15, 2019
Kimberley is one of three partners at ShortFinancial. She is a portfolio manager and investment advisor, who specializes in financial and insurance planning. She is insurance licensed and has successfully completed her CFP designation.
Question: “Given recent drops in performance, are you likely to shift focus in your portfolios away from FAANG stocks – the five technology giants trading publicly in the US?”
The temptation many investors fall into is to focus their attention on one or more sectors that have risen significantly during the last number of periods. This is understandable because everyone loves a good story and specifically, we love a story about gains in the stock market.
This is the case with FAANG (Facebook, Amazon, Apple, Netflix, Alphabet’s Google) stocks. These stocks have really delivered most of the gains in the US market over the last year and the recent weakness in some of these stocks attracts a lot of attention. However, we have to be aware that financial headlines often miss the big story. That is, the attention to gains or losses in one sector is one form of recency bias in our industry. Our job, as Portfolio Managers, is to ensure that we steer clients away from potential hazards caused by this type of bias. Recency bias can cause a mania to set into a particular sector which, although it can lead to some short term profits, is rife with a history of casualties, particularly among novice investors.
The most startling example of recency bias arguably was the banks that benefited by the US housing bubble that ended in 2007, and before that we had the dotcom mania in 2000. Short term profits were made by many early investors who were investing at low prices when the companies had good value, but this became a game of musical chairs when valuations exploded and fear of missing out drove stock prices well above reasonable levels. The losers at the end far outnumbered the early winners.
Knowing when to take profits before the music stops is the hardest part of this strategy. Therefore we refuse to play these games and use a variety of tactics to ensure that our clients keep FAANG stocks and other sectors in proper perspective.
That said, we have included some of these stocks in our portfolios over the last number of years. Our portfolio management methodology requires that with any stock, the underlying fundamentals have to be sound which, with many of the FAANG stocks, eliminates them from our consideration. Then, the discipline of actually taking profits as stock prices have increased has gone a long way to smoothing returns. Yes, we have left money on the table but we believe we would rather be looking at cash in our hands as a stock we sold continued to rise than to be looking at a stock we own crash because we were hoping to squeeze out the last few pennies of profit; we’d rather be looking at the cash than looking for it.
So the recent weakness in some of these stocks is only one factor in our review of these companies. In the same way, we saw weakness in major US banks in early 2008. Even a 20% fall in price did not make these banks undervalued at the time – it just made them less overvalued, which turned out to be too true when that party ended later that year. Fundamentals always matter, as does diversifying - by buying out of favour, unfashionable stocks as a counterbalance.
We are intrigued when investors fall deeper in lust with a company that has romanced us all with futuristic-feeling innovations, like the promise of drone delivery of our online shopping purchases and fast food orders. It becomes easy to then regard the fundamentals of the company as unimportant, and to ignore its volatility within one’s portfolio. At the extreme, no longer do most investors look at P/E ratios or dividend yields as a metric for analysis of a company, but rather, sentiment and momentum indicators become the decision making tools. However, trying to time those extremes is fraught with danger.
We also recognize that as Canadians invest in FAANG stocks there is currency risk. Since 2016 we have seen the Canadian dollar stay relatively weak against the US but we cannot fail to remember that it was only 2008 when our dollar was above par to the US. Any spike in inflation, any commodity shortage, or a crisis in the volatile US political system could cause our dollar to rise just as the volatile FAANG stocks sell off.
Geographic diversification for Canadians remains a critical component to both risk management and yield realization. Overall, understanding our client’s objectives for their portfolios is as important as the security selection criteria we use. For some, being weighted in these fast-moving stocks will make sense, as long as clients, and we, keep remembering that FAANG’s can bite.
This information was prepared solely by Larry Short who is a registered representative of HollisWealth®, a division of Industrial Alliance Securities Inc. (iA Securities), a member of the Canadian Investor Protection Fund (CIPF) and the Investment Industry Regulatory Organization of Canada (IIROC).The views and opinions, including any recommendations, expressed in this article are those of Larry Short alone and not those of HollisWealth®
BComm, CPA, CGA, CIM®, CFP®, FCSI
Portfolio Manager & Executive Director, Private Client Group
In Short: Secrets to Make Your Dollars Grow
HollisWealth® is a division of Industrial Alliance Securities Inc. (iA Securities), a member of the Canadian Investor Protection Fund (CIPF) and the Investment Industry Regulatory Organization of Canada (IIROC). iA Securities is a trade name and business name under which Industrial Alliance Securities Inc. operates. This information has been prepared by Larry Short, Portfolio Manager for HollisWealth®, a division of iA Securities, and does not necessarily reflect the opinion of iA Securities. The information contained in this document comes from sources we believe to be reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces where he is registered. For more information about HollisWealth®, please consult the official website at www.holliswealth.com . ShortFinancial is a personal trade name of Larry Short.
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