The FANG stocks – consisting of Facebook, Amazon, Netflix, and Google – have been the talk of Wall Street for as long as anyone can remember in this bull market. Chalk it up to industry dominance, massive free cash flow, fast growth and surging stock prices.

But is there also too much hype baked into their respective stock prices? In 2017, from January 1 through September 15, each company has materially outperformed the broader S&P 500 Index:

  • Facebook: +38%
  • Amazon: +23.82%
  • Netflix: +41.59%
  • Google: +13.10%
  • S&P 500: +10.18%

Zacks Investment Management has largely maintained a bullish outlook on the technology sector and these players in particular, and it has been a positive contributor to total return throughout this bull market. But, like any good thing in the market, the outlook for these companies must be held in balance with the risks looking ahead. These stocks, and arguably the tech sector as a whole, have become one of the more crowded trades in today’s market, and many investors are starting to show signs of complacency particularly when it comes to steep valuations. That’s not a great sign.

‘Short Interest’ as a Sentiment Indicator

Remember that too much optimism can be a bad thing, and a key indicator that measures optimism vs. pessimism – which is also an indicator we use quite a bit here at Zacks Investment Management – is starting to tilt further to the optimistic. That indicator is short interest, which refers to the quantity of stock shares that investors have sold short but not yet covered or closed out. A high level of short interest indicates that a large number of market participants are bearish on the stock, whereas a low level of short interest means very few investors are willing to short the stock.

FANG stocks now have short interest at multi-year lows, indicating that the bulls far outweigh the bears. Normally, that is not automatically a problematic indicator, but when you look at FANG stocks it becomes apparent that the needle has moved quite far in the bullish direction. Collectively, at the end of August, the short bets against FANG stocks accounted for just 2% of their traded shares. Exclude Netflix, and the average short interest for the group drops to just 1%. Compare that to an average of 4% short interest on companies in the S&P 500, and you can see an optimism bordering on euphoria. That raises some eyebrows around here.

However…The Business Landscape Continues to Favor FANG

In my view, the factor that keeps the FANGs in the positive column, for now, is the business landscape. As it stands today, these tech giants (and a few others) are operating what arguably amount to lightly regulated monopolies. These ‘monopolies’ are not being broken up or over-regulated for several reasons. Among them: the government does not fully understand the marketplace; size in this case is actually causing a reduction in consumer prices, not the opposite; and regulating tech companies is fairly low on the list of legislative priorities.

The fact that the government is a few steps behind in regulating tech companies is good for investors but bad for the competition. Normally, with profit margins as attractive as those of FANG and others, we would see competitors flooding the market. Not the case today. The barriers to entry are simply too massive. Consider if an enterprise technology company wanted to compete with Google and build a better search engine, or if a large national retailer wanted to develop a better e-commerce platform than Amazon. Near impossible! Effectively, the high profit margins of FANG stocks should be attracting competition but the natural monopolies that are developing are providing the FANG group with plenty of runway for strong growth ahead, at least in the near term. All of this is very good for investors, but not so great for creating a dynamic economic environment. On the other hand, we certainly are better off that these natural monopolies are developing in the U.S. as opposed to overseas.

Bottom Line for Investors

Moving forward – and by ‘forward’ I mean the next six to twelve months – it will be crucial to keep a close eye on the regulatory environment. I stated before that regulating tech companies is fairly low on the list of legislative priorities, and I believe that to be the case today. But, following revelations about Russian “troll farms” buying up ad space and distributing fake news on Facebook during last year’s election, big tech has become a bigger target for legislators. Members of Congress from both parties have begun exploring possible legislative action against Facebook and other tech giants, which could set the stage for significant battles and debates leading into midterms next year. The relative comforts of little regulation for big tech may be nearing an end, and if the hammer drops the wrong way, it could very well be the factor that ends the FANGs’ historic run.

Now the question becomes, “How could changes in regulation shift the market landscape?”

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