Market Insider

Risk and reward could continue to be high in FANG stocks, even if they lag this year

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Key Points
  • With the stock market at record highs, analysts expect the best gains to come this year from the cyclical sectors.
  • As the economy looks set to improve, cyclicals like industrials and materials are expected to lead the market higher, but growth is still getting a bid.
  • Analysts say the big growth names, like FANG could lag, but they may still rise on earnings and hold onto gains better if investors become worried about the economy.
Traders on floor of the New York Stock Exchange.
Source: New York Stock Exchange

Cyclical stocks that do well in a stronger economy are widely expected to lead the market higher this year, but don't count out big tech stocks altogether — they may provide shelter in any market storm.

When the major stock indexes hit record highs across the board Wednesday, the FANG names were right there with them, leading the market higher. For the week so far, communications services is the best-performing sector, up 6% followed by tech, which has risen 4.5%.

The Nasdaq and S&P 500 closed at record highs again Thursday. Most FANG names — Facebook, Amazon, and Google parent Alphabet — continued to rise. Netflix, however, was lower Thursday after a sharp post-earnings rally.

Jack Ablin, CIO at Cresset Wealth Advisors, said retail investors are continuing to drive the big growth names higher, and he has lightened up on them despite the momentum. Earnings for big tech and FANG are expected over the next two weeks, with Microsoft on Tuesday and Apple and Facebook on Wednesday.

"Near-term, investors probably want high-quality companies that are making money," he said. "Valuation by itself is not a timing tool and expensive stocks can get more expensive. I think they have risk. We did take some of our growth risk off the table at the beginning of the year."

Big-cap growth is expected to lag this year, but it may be an important source of solace if the market pulls back. Many strategists say the market is overdue for a correction and it could sell off in the next couple of months. They mostly expect a fairly shallow swoon and say it should be a dip buying opportunity.

"The thing about growth is it always seems to come through in earnings season," said Lori Calvasina, chief U.S. equities strategist at RBC. "They continue to put the numbers out. ... Putting the earnings aside, I looked at the performance [Wednesday] and saw the defensive growth trade working."

The biggest tech names, Apple and Microsoft, followed by Amazon, Alphabet and Facebook were the biggest contributors to the market's gains last year. When the market began to rise after the sharp coronavirus pandemic-induced sell-off in March, it was those stocks that led in a broader stay home trade.

Calvasina said fears about the pandemic may be encouraging investors to put money back into growth stocks despite their high valuations. One big risk to the sector — and to the overall market — is if the companies face regulatory action. Facebook, Alphabet, Amazon and Apple are all under antitrust scrutiny in the U.S. or Europe.

Ablin is among those who expect a market pullback, and how much growth names are hurt depends on what triggers the decline.

"All things being equal and the market drops, it is going to be the FANG stocks that probably fall more. If the market drops in response to some economic disappointment then it will likely be the cyclical stocks that decline more," Ablin said.

For now, the market is being buoyed by optimism the economy will be helped by a major stimulus package proposed by President Joe Biden, the rollout of Covid vaccines and easy Federal Reserve policy. The S&P 500 is up 2.3% so far this week.

Robert Sluymer, technical strategist at Fundstrat, is another who expects a sell-off, and he sees it coming soon.

"Our outlook remains unchanged, bullish for equities through 2021 while expecting a tactical pause/pullback to develop by mid Q1, potentially as early as month-end," Sluymer wrote. He said weekly momentum indicators are signaling overbought levels heading into the middle of the first quarter.

"Short-term, we are expecting the S&P to push toward 3900-4000, at which point short-term trading indicators are likely to be overbought and peak," he added. "Looking through Q1, we expect the pullback to be relatively shallow (7-10%), short lived and dominated by sector and group rotation."

Sluymer said cyclicals are showing signs of strengthening which should continue, but he said growth stocks are showing improvement.

"After pausing through Q3-Q4 growth stocks are again timely with EBAY continuing to accelerate, NFLX surging after hours [Tuesday] from support and AMZN and CRM timely nearing support," he noted.

Calvasina has recommended overweighting financials, materials and energy, and she is underweight communications services, consumer staples and REITs. Facebook and Alphabet are in the communications sector.

She said the growth stocks will continue to rise.

"When we look back at this year as a whole, they're going to be up but they're not going to be up as much as the market," Calvasina said. She expects a shallow pullback but also says it could be worse, in the mid-double digits.

"I think it'll be a little bit choppy," she said. "None of our overweights ... are going to work in a pullback. We think it's one big trade. You're going to gyrate between cyclicals and undervalued stocks, and growth."