The FANG Stocks Have Potential To Really Bite Investors

The so-called FANG stocks have accounted for much of the stock market rally we are witnessing, however, it might be wise to step back and question the fundamentals behind the upward movement of these stocks. Fang is the acronym for four high performing technology stocks, it includes Facebook, Amazon, Netflix, and Google. Sometimes it is spelled FAANG to allow in another tech stock, Apple, this adds to the illusion of stability. Other stocks sometimes considered as part of this category of high flyers are stocks like Tesla which sadly starts with the letter T causing it to be left out. Not fitting neatly in the acronym, however, does not stop it from having a valuation exceeding that of Ford Motor Company which produces a profit and far more vehicles while Tesla loses money and continually burns through billions of dollars of cash each year.

Momentum traders have been aggressively buying tech stocks and as they do this creates a "short squeeze" where bears or short sellers panic adding fuel to the fire. In a short squeeze, short sellers panic and buy to cover to cut their losses. We are taught that the value of any company is the present value of all future cash flows. But this rule of measurement is often thrown out the window when it comes to FANG stocks. Netflix's recent earnings release showed the company as reporting negative free cash flow of over $2 billion. Not only that, but the company projected negative free cash flow of $3 billion to $4 billion for 2018. This means Netflix has a cash burn equal to the entire market capitalization of some mid-cap companies yet Wall Street reacted with a stunning 13% surge in the stock.

FANG Stocks Have Been The Momentum Behind This Market!

Stocks that trade at crazy multiples such as Amazon at around 350 times earnings ignore and defy reality. To give a stock such a valuation an investor has to almost believe in divine destiny and that the company will never encounter headwinds that will bring it back to reality. It is ironic that the online retailer Amazon bought Whole Foods paying top dollar to go against Kroger with a PE of 17 times earnings. This move was heralded as brilliant rather than a reality check. How can the earnings of a food chain leap in value from a multiple in the teens to a multiple of several hundred? Also, anyone who is rational must wonder how Amazon can continually float stories about building a Brick and mortar" presence without negatively affecting its multiple. It seems that with the faith of a gambler those driving the stock forward always think they will be able to leave the casino before losing their gains.

Part of this boils down to greed and that investors tend to get caught up in the emotional hype that the value of a growing company will continue higher and higher so they should get on that train and ride it all the way to the station. At the same time once aboard they delude themselves of the reality of new competition, market setbacks, and the possibility as the company matures its stock will be brought back into line with the market in general. We should never forget that even the tallest trees never grow to the sky and that at a certain point growth slows.

The Above Chart Details The Four Phases Of A Bubble

We should not forget that this market has been going up for a long time, this is the longest bull market in history. After roughly a ten year orgy of central bank stimulus many investors have become convinced of the idea that "central banks will never let markets go down." This has led us to the recent market melt up over the last year where the buy the dip mentality has been replaced by the fear of missing out. This, of course, has turned most of the few remaining market bears and those doubting the strength of the economy to capitulate and stampede to the exits or risk being turned to dust.

The fact is nobody can really predict what the future holds, however, it is difficult to deny a strong case for caution can be made in that the recent psychology of this market aligns well with that of a blow-off top. A key requirement of such a market is that almost all the participants are in complete denial of the risk they face and have borrowed strongly against their future to join in to get a share of the bounty that lays before them. This means not only do they accept the current sky-high valuations as rational but see a great deal of room for earnings to expand as the pace of global growth accelerates.

Circling around to the title of this piece, FANG Stocks Have Potential To Really Bite Investors, it is logical that these so-called bright spots that have pulled the market higher also have the most room to fall as valuations retreat. Today there are signs that central banks are becoming more concerned about asset bubbles growing as a direct result of their promoting the belief they will always be there backing economies with newly printed money. All this has driven a massive surge in debt across the globe as consumers, businesses, and governments have thrown caution to the wind setting up a scenario that ends in tears.