- The U.S. stock market is dangerously concentrated in just five companies.
- Those five companies – Facebook, Google, Amazon, Microsoft, and Amazon are all reporting earnings this week.
- If all five disappoint, it could trigger a wave of selling that brings down the whole market.
This week is make-or-break for the stock market. And it all comes down to five stocks:
Facebook, Google, Apple, Microsoft, and Amazon.
These five tech giants are all reporting earnings this week. And here’s why it’s such a big deal:
This chart shows how concentrated the stock market is right now. These five stocks make up a whopping 24% of the S&P 500 market capitalization. Throw in Netflix, and it’s a full quarter.
The S&P 500 hasn’t been this concentrated since the 1970s.
This is dangerous.
If all five companies miss expectations on earnings this week, it’s game over for the stock market. In other words, these five stocks have the ability to drag the entire market down in one fell swoop.
Goldman Sachs warns about stock market concentration
This phenomenon is even making Wall Street nervous. Goldman Sachs analysts wrote a letter to clients explaining what usually happens next:
Sharp declines in market breadth in the past have signalled large market drawdowns.
In other words, when the market is highly concentrated in a small handful of companies, it often triggers a reversal. This concentration can go on a long time, the analysts wrote (two years during the dot-com bubble, but typically usually a few months). But whenever it happens, we often see lower-than-average returns.
Why does it happen? Well, during times of panic, such as now, investors turn to large companies with strong balance sheets. It’s a defensive move. They flock to companies that have already been outperforming, pushing their lofty valuations even higher. It happened in 2000, 2008, and – to a smaller extent – during the 2011 and 2016 corrections.
This admittedly ugly chart shows how dominant the tech-5 are right now. Facebook, Google, Amazon, Microsoft, and Apple are equal to the bottom 350 stocks in the S&P 500.
Can FAANG stocks survive the week?
This week will define the next phase of the stock market. All five companies will deliver earnings reports this week. And it could get nasty.
Facebook has already admitted the coronavirus has ‘adversely affected’ its business. Some estimates suggest that Facebook’s cost-per-click rate for advertisers has fallen 50% as demand from small businesses dries up.
Microsoft has warned that PC sales will take a hit in the wake of the virus. And cloud software clients are desperately asking Microsoft if they can defer their payments.
Apple has closed 485 stores outside of Greater China and the company’s supply chain is in tatters. In a hint of what’s to come, iPhone sales in China dropped 28% in January, when lockdowns were first brought in. The impact in Europe and the U.S. will be even longer and more protracted.
Stock market cracks starting to appear?
Even Amazon, which is up more than 20% year to date, just got a downgrade on Wall Street. R5 Capital issued a ‘sell’ rating on Amazon stock. They think Amazon will begin to struggle in four of its main money-making segments. Namely, subscription services, third-party sellers, AWS (cloud) and advertising.
R5 lowered its price target on Amazon to $1,987 per share. That’s about 20% lower than it is right now.
Morgan Stanley analyst Michael Wilson thinks we’ll begin to see some more cracks emerge during earnings season. As more and more analysts start to revise estimates downwards, we’ll see a trickle effect that could “unwind’ the S&P 500 market cap concentration. And if that happens, we might see the whole house of cards come back down.
As some analysts have predicted, we may not have seen the worst of this stock market crash yet.
Disclaimer: The opinions expressed in this article reflect the author’s opinion and should not be considered investment advice from CCN.com. The author holds no investment position in the assets mentioned above.
This article was edited by Samburaj Das.