Skip to main content
strategy

Stop worrying about the FAANG stocks. What investors should really be concerned about is being chewed up by the GUMM stocks.

A small group of large technology stocks – Facebook Inc., Amazon.com Inc., Apple Inc., Netflix Inc. and Google's parent, Alphabet Inc. – have risen sharply this year. Some fear that they will come back to bite investors. But most market strategists have said that doesn't mean the stock market is in a bubble. The FAANG stocks trade, compared with income or sales, considerably below where the largest and most expensive dot-com stocks were in the late 1990s, which in retrospect was very much a bubble. The stock market's overall 19 price-to-earnings multiple based on this year's bottom lines is also below the 29 it was at the end of 1999.

But while most investors have been focusing on the stock market's most expensive stocks, and saying they still look relatively cheap, they have been missing another perhaps troubling trend: The market's cheapest stocks look relatively expensive. The average P/E, based on the next 12 months of earnings, of the 10 stocks with the lowest multiples in the S&P 500 is 6.8. At the end of March, 2000, the same figure was five, or 26 per cent lower then where it is now, and that was at the height of the dot-com bubble. The S&P 500's lowest 100 P/E stocks, the bottom quintile, have a P/E of nearly 11, compared with just below eight, for the same group in 2000.

Unlike with the market's most expensive stocks, where A's are prevalent (some have suggested the correct tech rally acronym should be FAAA), the S&P 500's lower price merchandise bin has a number of companies that start with the letter U. There is airline United Continental Holdings Inc., United Rentals Inc. and disability insurer Unum Group, with P/Es of 10, 10 and ll, respectively. General Motors Corp., with a P/E of just less than six, is the second-least expensive stock, relative to earnings, in the S&P 500, followed by drug company Mylan NV. Retail chain Macy's Inc., at a P/E of nearly eight, isn't too far from the bottom.

And it's not just the lowest-priced stocks that look expensive relative to history. Of the five market quintiles by valuation, just the highest group is trading at a discount to 2000, 44 versus 50 just more than 17 years ago. The other four valuation quintiles are trading above where their respective group was back in 2000. Low interest rates are part of it. That leads investors to buy into utilities and other higher-yielding but low-growth stocks that would normally have few buyers at this point of an economic cycle but are now a substitute for bonds.

But passive investing is also likely part of it. There was relatively little of it in 2000. Now nearly half of all investments are tied to an index. That has created a lifting-all-boats effect, at least for the stocks in the most popular indexes. And it's cut down on what market experts call the valuation dispersion.

Does this mean the stock market is overvalued? The fact that four of my five value quintiles are above where similar groups were at the height of the dot-com bubble seems like something to be concerned about. Of course, GM's stock seems cheap. But saying whether it's cheap enough to compensate for its slowing earnings and threat from self-driving cars is similar to trying to determine whether Amazon's potential to take over the retail world is great enough to justify its high price. It's hard to tell.

But what seems true is that passive investing, and low interest rates, while being a significant force that has driven the current bull market longer than most others, has also made it less safe, leaving fewer places to hide when the market inevitably drops.

Stephen Gandel is a columnist with Bloomberg News.

Rob Carrick goes over some ups and downs of investing in dividend stocks, bonds and GICs.

Interact with The Globe