How to Hedge a Plunge in the FAANG Stocks

The current bull market owes a lot to the electrifying rise of the tech sector, as the past five years has seen the Nasdaq 100 rise by more than 140%, with much of those gains attributable to the FAANGs—Facebook Inc. (FB), Amazon.com Inc. (AMZN), Apple Inc. (AAPL), Netflix Inc. (NFLX), and Google parent Alphabet Inc. (GOOG). But with such incredible rises, the valuations of the big tech stocks are starting to look stretched, and investors may want to find a hedge in the case of a market downturn. Considering current valuations and past performance, CenterSquare Investment’s chief investment strategist Scott Crowe demonstrates how commercial real estate can provide that hedge, according to MarketWatch.

Valuation and Performance

Crowe points out that, since early 2012, valuations for real estate investment trusts (REITs) have been falling relative to the overall U.S. equity market. Compared to the FAANGs, the relative decline is even more glaring. As of the end of March, the FAANG forward price-to-earnings ratio (P/E ratio) is 53.9. Using funds from operations (FFO), a metric used in the REIT industry to gauge dividend-paying ability, the forward price-to-FFO ratio for the REIT sector is 16.5.

 Stock/Index Forward P/E Ratio or Forward P/FFO Ratio (as of July 13)
 Facebook 24.3
 Amazon 107.2
 Apple 15.0
 Netflix  109.5
 Alphabet (Class A) 25.3
 S&P 1500 Real Estate Sector 16.5

Data: MarketWatch, FactSet

From the above chart, it can be seen that, except for Apple, the FAANGs are trading at higher valuations than the real estate sector, and significantly higher in the case of Netflix and Amazon. (To read more, see: Tech Stocks Could Drag Down the Market: Wells Fargo.)

As for past performance following market busts, REITs rose 6% per year over the three years following the dot-com bubble, while equities decline by 17%. Following the global financial crisis, REITs rose 36% each year for three years versus a 23% gain for equities. Averaging over those two periods, the gain for REITs has been 21% and for equities, just 3%. Crowe notes, “the flavour du jour of the equity market changes over time, but commercial real estate endures,” according to MarketWatch.

Among the top 10 holdings of CenterSquare’s AMG Managers Real Estate Fund as of May 31, five that have shown strong performance over the past five years include Prologis Inc., CubeSmart, Alexandria Real Estate Equities Inc., Kilroy Realty Corp., and Simon Property Group Inc.

 REIT 5-year Total Return (through July 10)
 CubeSmart 131%
 Alexandria Real Estate 120%
 Prologis 103%
 Kilroy Realty 62%
 Simon Property Group 37%

Data: MarketWatch, Morningstar, FactSet

Tech-Sector Risks

Back in June, chief investment strategist at The Leuthold Group, Jim Paulsen, reiterated numerous months of warnings that investors were still overweight the biggest tech stocks. He compared the current environment, where “everyone is going into the same, very narrow number of popular names,” to the dot-com bubble of the late 1990s. He advised investors that it is probably time to cycle out of tech into more defensive stocks in order to hedge against a market downturn. REITs may be just the hedge investors are looking for. (To read more, see: Sell Tech Stocks Now Before Bubble Bursts: Paulsen.)

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