Is a Change in Leadership Underway?

“The public buys the most at the top and the least at the bottom.”
—Bob Farrell
Legendary Analyst
 
Looking at recent fund flow data, the perspective offered by Mr. Farrell above seems like a prudent warning for investors still obsessed with Big Tech and go-go growth darlings. 
 
According to Thomson Reuters, Tech-focused funds have seen record inflow this year.
 
As billions flow into big-name Tech, prices skyrocket: Year-to-date, Netflix, Inc. (NFLX) is up over 54%. It’s not alone. Amazon.com Inc. (AMZN) has soared 24%. This price action has launched valuations into the stratosphere: Netflix is priced at over 100x estimated earnings. Not to be outdone, Amazon trades at 172x. 
 
This short-sighted focus on Information Technology (IT) has created a very narrow market, which is not normal, nor healthy—we’ve already seen some painful wobbles in late March and wouldn’t be surprised to see many more in the months ahead. Once again, a handful of stocks—FAANGs (Facebook, Inc., Apple Inc., Amazon.com, Inc., Netflix, Inc., and Alphabet Inc., parent company of Google)—are driving year-to-date performance. 
 

Time for a Reboot?

We believe the equity market is at an inflection point and selling pressure late in the quarter is signaling Value is poised to outperform momentum/Growth. Here is our reasoning:
 
  • Reversion to the mean. We are in one of the longest stretches of growth beating value in modern history—the gap between haves and have-nots has reached a level that is difficult to ignore!
  • Higher interest rates traditionally favor active value management. Not all businesses are impacted the same by higher borrowing costs; it takes active analysis to separate the winners from losers.  
  • Leadership change. Facebook, Inc. (FB) is under attack here and abroad—can additional regulation be far behind? If so, will the market treat it as a Utility instead of a tech high-flyer?
  • Lower taxes. Recent tax reform is pro-growth and should reduce the burden on small companies and encourage business investment. 
  • Law of big numbers—AMZN has a market cap of $693 billion—it will take more than chump change to move the performance needle on the Big Tech names highlighted below.
A Sizeable Challenge
Top 10 Holdings in S&P 500 Index
Heartland Advisors Top 10 in S&P 500 Index Chart
Source: FactSet Research Systems Inc., Standard & Poor's, and Heartland Advisors, Inc., as of 3/29/2018
Top 10 holdings in S&P 500 are being shown in order by market value (highest to lowest). Market values displayed in red indicate holding is from the IT sector.
 
So who will take the baton once Big Tech loses its way? While we don’t make industry or sector calls, we do believe that tomorrow’s leaders will have common characteristics:
 
  • Unique niches to serve
  • Strong balance sheets
  • Capable, committed management
  • Compelling valuations
Identifying these traits continues to be the foundation for our work at Heartland, and focusing on them is one of the surest ways we know of avoiding the flawed approach Mr. Farrell describes.
 
We thank you for your continued trust and confidence.
 
Sincerely,
Your Heartland Team

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