Tech volatility is growing, but Bank of America has tips to help investors.
According to Canaccord Genuity’s Monthly Internet Dashboard, the FANG stocks, Facebook, Amazon, Netflix, and Google are up ~48%, ~29%, ~41%, and ~19%, respectively year-to-date, while the S&P 500 is up ~10%.
Even though these companies are reporting some of the fastest revenue growth rates in the S&P 500, Canaccord’s analysts note that it will be “very tough” for this kind of outperformance to continue.
However, the four strong secular tailwinds (digital advertising, eCommerce, digital video, cloud), driving FANG performance, coupled with the group's "reasonable valuations, freedom to make long-term bets with a surplus of resources, and growth" are all supportive of continued strength in the stocks. Only 17 large-cap stocks are expected to grow revenue faster than 15% next year, a quarter of these are FANG's so large-cap managers have little choice but to include these firms in portfolios if they want to keep up with the market.
How To Protect Against Rising Tech Volatility
Owning tech stocks has become harder over the past 12 months. A new report from Bank of America points out that over the past six months alone, the sector has suffered four daily drawdowns exceeding three standard deviations, "the highest number in such a short time span in history."
As a result of these short, sharp drawdowns, tech has generated higher realized volatility vs. the rest of the market. BoA's report notes that this has pushed the relative cost of optionality higher with the ratio of the Nasdaq VIX to the VIX currently standing at 1.3, in the 95th percentile over the past ten years.
With options anything but cheap on Tech relative to the rest of the market, BoA's report recommends that investors should " screen for cheap volatility on select names or find effective strategies to reduce the upfront premium outlay" if they want to buy into the sector and minimize risk.
The report also recommends using options as a way to trade the tech sector and protect against the risk of another sharp sell-off as risks grow. In particular, the report points to rising valuations, crowded positioning, and a "high weighting within the typical momentum factor strategy" as reasons to add downside protection.