Goldman says these are the biggest threats to the dominant 5 tech stocks

Published Mon, May 10 20219:53 AM EDTUpdated Mon, May 10 202112:35 PM EDT

The so-called FAAMG stocks — Facebook , Apple , Amazon , Microsoft , and Google-parent Alphabet — have evolved into dominant juggernauts in the market, but Goldman Sachs is warning about a few threats to the high-flying group. Investors are wondering if there will be a reckoning that causes a shift in the market leadership of these five names. Overall, Goldman Sachs does not see these technology darlings falling out of favor anytime soon. However, the group faces a handful of threats. High market concentration, changes in the tax code, rising interest rates, lofty valuations and intervention from regulators are Goldman's top concerns for the beloved FAAMG names. The first concern for Goldman is the fact that the FAAMG group collectively makes up 21% of the S & P 500 market capitalization, well above the historical 14% average of the top five stocks. This level is also higher than the 18% average during the technology bubble. "The large index weights of the top stocks are also a practical headwind to continued appreciation given SEC restrictions on portfolio concentration that limit how much mutual funds can continue to buy them," David Kostin, chief U.S. equity strategist at Goldman Sachs, told clients. Kostin also said the five stocks are vulnerable to higher capital gains taxes. Indeed, President Joe Biden has proposed raising the top rate on long-term capital gains from 20% to 39.6%. The tax hike would apply to households making more than $1 million. The FAAMG stocks have appreciated by $5 trillion during the past five years as investors concentrated on a small number of growth names. Many investors have significant gains from the FAAMG stocks, and the prospect of higher capital gains taxes could motivate selling. "If the capital gains tax rate becomes set to rise in 2022, investors subject to the higher rate may choose to realize some of their substantial capital gains in 2021 at the lower current tax rate," added Kostin. Further, price appreciation over the last five years has brought these stocks to high valuations. "At first glance, valuation multiples also appear to pose a risk to the FAAMG stocks," said Kostin. "Investor conversations around FAAMG inevitably turn to their valuations." FAAMG trades at a forward price-earnings ratio of 29 times, which is in the 90th percentile for the top five stocks since 1980, compared with 21 times for the remaining 495 S & P 500 stocks, according to Goldman. Rising interest rates are another major threat to the group, according to the investment bank. Interest rates have increased steadily in 2021 as recovery from the coronavirus pandemic has accelerated. The FAAMG stocks rely on low interest rates for borrowing money to reinvest in growth. Higher interest rates can also lower their valuations by making their future earnings growth worth less today. "All five FAAMG stocks have above-average duration compared with the Russell 1000, meaning they are especially sensitive to moves in long-term interest rates. As yields rose sharply from November through March, FAAMG underperformed the S & P 500 by 7 [percentage points] (+21% vs. +14%)," said Kostin. Goldman said the greatest risk to the continued market leadership of the FAAMG names is the potential intervention of regulators. "Recent Biden administration appointments suggest some risk of a stricter regulatory regime and tighter antitrust enforcement," said Kostin. "With the exception of MSFT, the other four FAAMG stocks face a laundry list of legal battles and investigations over their market power and competitive practices ranging from commercial litigation to DoJ and FTC antitrust lawsuits to Congressional probes," Kostin added. — With reporting from CNBC's Michael Bloom.

Justin Tallis | AFP via Getty Images

Investors are wondering if there will be a reckoning that causes a shift in the market leadership of these five names. Overall, Goldman Sachs does not see these technology darlings falling out of favor anytime soon.

However, the group faces a handful of threats.

High market concentration, changes in the tax code, rising interest rates, lofty valuations and intervention from regulators are Goldman's top concerns for the beloved FAAMG names.