The FAANG stocks have had a torrid time in the first half of 2022. Every one of them is significantly off their highs reached at the end of 2021. Red hot inflation and the fear of rising interest rates has seen a flight to safety to more traditional businesses, notably energy and miners. However, in the last couple of weeks we have seen a rally amongst these stocks. Alphabet’s (NASDAQ: GOOGL) share price is up 8% since the last week in May. My fear is that what we could be witnessing is a bear market rally. Investors buying the dip now need to appreciate that significant downside risk still remains.
Innovation powerhouse
Alphabet is a business that I have long admired. When it floated on the stock market in 2004, the dotcom bubble had fully deflated and scepticism was abound. Indeed, back then, Google’s business model was viewed as a bit of a joke in some quarters. Today, the company has a market cap of $1.5trn.
Google’s mission statement of organising the world’s information, and making it universally accessible and useful, is one of the simplest but most impactful in Silicon Valley. It has harnessed the power of the internet unlike any other company in history. After all, it doesn’t own the web pages it scans.
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Throughout its short history, the company has continually innovated, looking for new ways to approach its mission statement. AI and machine learning has been at the heart of this.
Recently enhanced search offerings have included Multitask Unified Model. This technology aides a user by reducing the number of searches required for help completing a complex task. During the pandemic, for example, this was used to improve searches for vaccine information. It was able to collate results in many different languages and, at vaccination centres, aid in navigating through tricky indoor spaces.
Bear market territory
If I admire Alphabet so much, then why will I not buy it now? The reason is because I believe the business cycle has turned and the investing strategies that worked during that last cycle won’t work any more.
Many investors are conditioned into believing that buying the dip is a winning strategy. It was when you had the Fed on your back, buying up treasury issuances and printing money like confetti. But those days of loose fiscal and monetary policy are now long behind us.
I believe that the Nasdaq topped out in late 2021 and we won’t see those highs again for many years.
Warren Buffett’s favourite market indicator, market cap to GDP, is still flashing red. At the moment, the Wilshire 5000, which represents the total US stock market, stands at a near-record 187% – having reached over 200% six months ago.
As the staying power of inflation becomes increasingly evident, policy makers will be forced to raise interest rates far more than what the market is pricing in at the moment.
A year ago, central banks were touting the notion that inflation was transitory. They were wrong there, just as I believe they are wrong in their views now. Therefore, however good a business Alphabet is, I will not be buying any time soon. The downside risk is simply too great for me.
