AAPL Apple Inc

By James Mackintosh 

To get a sense of how much better U.S. blue chips have done compared with the rest of the world as the global economy is ravaged by coronavirus, consider this: Nasdaq-listed stocks were briefly worth more than the main index of developed markets outside the U.S. last week, having been worth only half as much five years ago

This and similar extraordinary comparisons should make investors pause for thought. How sustainable is it that the biggest stock, Microsoft, is closing in on the value of the whole of London's FTSE 100, an index that includes global giants such as Royal Dutch Shell, HSBC and Unilever?

How reasonable is it that the value of the five biggest U.S. companies -- Microsoft, Apple, Amazon, Alphabet and Facebook -- is now more than five entire S&P 500 sectors? Or that those five companies make up 20% of the value of the index, up from 16% at the start of the year and the most since the 1970s, according to data from strategist Tim Edwards of S&P Dow Jones Indices?

Many have been warning of froth in tech stocks for years. If they are a bubble it just keeps inflating. These and other highly-profitable, fast-growing companies beat the rest of the market in the bull run. And they beat it again in the bear market.

Their success explains why the U.S. has done so much better than other markets, too. The equal-weight S&P 500, in which Amazon and Microsoft are given the same weight as a department store or oil company, is down almost as much European or British stocks (in dollar terms) since the market peaked in February.

What can't go on, won't go on. Yet there are solid reasons why the leading U.S. companies are doing better than the pack as what could be the deepest recession since the Great Depression takes hold.

First, these companies tend not to be heavily indebted, and many are sitting on piles of cash. Microsoft, for example, held $134 billion of cash and short-term investments at the start of this year. The most important investment question to ask before buying anything at the moment is whether a company can survive a deep recession. The big U.S. growth companies can mostly answer: Yes.

"Do you survive to the sunny uplands of 2021?" asks Neil Robson, head of global equities at Columbia Threadneedle. "Those large-cap tech stocks don't have that question to face."

Second, many of the trends exploited by these companies are being reinforced by the lockdown, such as video streaming, online working, socializing and shopping, online advertising, videogaming and a move by many shops to prefer cards over cash.

Third, a deep recession will weaken incumbents in many industries, helping the tech giants disrupt their business models. Bricks-and-mortar retailers struggling to survive will find it even harder to beat Amazon. The same goes for other businesses competing with the rise of cloud computing or new media. The Silicon Valley startups that nip at the heels of the big growth companies are likely to find it harder to raise cash, too, reducing the threat from new rivals.

Finally, there is the recession trade. So long as investors expect a long-drawn-out U-shaped recovery, they will continue to worry about stocks sensitive to the economic cycle such as car makers and airlines. They will prefer quality companies, with features such as low leverage and reliable earnings, that can expand whatever the economy does.

Only if that reverses does the market rotate out of the big tech and growth names and back to cheap cyclicals. Such a bet on a V-shaped recovery was briefly visible on Friday when hope for a Covid-19 cure rose and lifted bombed-out stocks such as Boeing, Halliburton and Citigroup more than 10% on the day.

Even some of those who doubt the long-run prospects of the market's leviathans think they are a good place to be for now, because of their ability to withstand recession.

"At some stage we would expect tech to be one of the casualties," says Ian Harnett, co-founder and chief investment strategist of Absolute Strategy Research, but for now he's positive on companies with strong cash flow. The danger he sees in the longer run is that some of the big companies may be undermined by new regulations or find that even online advertising spending is sensitive to the economy.

I'm naturally a value guy who likes unloved stocks but, right now, many of the companies that were cheap because they were struggling before the lockdown are more like call options than stocks. If there is a V-shaped rebound, they will be amazing performers as their survival prospects rise. If there isn't, many will go to zero.

The tech giants offer the opposite bet. Rich with cash, they offer safety and a way to profit in a slow recovery. Unfortunately, much of their growth is already anticipated in the stock price.

Write to James Mackintosh at James.Mackintosh@wsj.com

(END) Dow Jones Newswires

April 21, 2020 06:08 ET (10:08 GMT)

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