March 28, 2018 / 4:53 PM / 6 months ago

CORRECTED-FANG stocks' bite has U.S. fund managers looking for alternatives

(Corrects paragraph 7 to show Permanent Portfolio funds have $2.7 billion in assets under management, not $17 billion)

By David Randall

NEW YORK, March 28 (Reuters) - Fund managers have begun to ditch so-called FANG stocks that powered the U.S. stock market to record highs in January and are slowly rotating into commodity-related shares and other value stocks which typically outperform in late-cycle recoveries.

Portfolio managers holding shares of Facebook Inc, Amazon.com Inc, Netflix Inc, and Google-parent Alphabet Inc say they are increasingly concerned that the data scandal that has sent shares of Facebook down nearly 15 percent year-to-date will spill over into all of the FANG stocks, imperiling the broad market's momentum at a time when there are no clear companies or sectors to take their place.

On Tuesday, an index which tracks the FANG stocks along with six other mega-cap technology stocks tumbled 6.3 percent, the biggest decline since September 2014.

Facebook rose as much as 1.5 percent in early trading Wednesday before falling into the red, one day after sources told Reuters that chief executive Mark Zuckerberg plans to testify before Congress. Amazon.com dropped 4 percent, while Netflix fell 5 percent. Google-parent Alphabet was slightly positive.

"There are legitimate concerns over the business models of these companies, and I expect that they will be ironed out in legislation" that will likely eat into their profit margins, said Michael Cuggino, a portfolio manager of the $2.7-billion Permanent Portfolio funds.

Cuggino, who would not say whether he was selling any of his shares in Facebook, said that commodity and industrial stocks look more attractive now given rising inflation and continued global economic growth.

Each FANG company rose more than 33 percent last year, helping power the S&P 500 to a nearly 20-percent gain. Yet those gains have left the broad S&P 500 trading at a high trailing price-to-earnings ratio of 21.7, leaving it overpriced despite a boost to margins from the Republican-led corporate tax cut at the end of 2017.

"Rising volatility and changing market leadership are now pointing towards the possible conclusion that the stock market peaked in late January 2018," said Douglas Kass, president of Seabreeze Capital Management.

The S&P 500 is now down 2.2 percent for the year, and down nearly 10 percent below the high of 2872.87 it reached on Jan. 26.

UNFRIENDED

Fund managers say that the high valuation of FANG stocks and the likelihood of regulation are pushing them into traditional value stocks like energy and defense companies.

Connor Browne, a portfolio manager at Thornburg Investment Management, said that he sold his shares of Netflix and Amazon.com last year after both companies blew through his price targets. He used those gains instead to increase positions in energy stocks such as pipeline operator Enterprise Products Partners LP and crude oil shipping company Overseas Shipholding Group Inc that stand to benefit from the recovery in the price of oil.

"We noticed that in all of this excitement over the FANGs taking over the world, there are parts of the economy that seem really out of favor and offer more compelling opportunities," he said.

Even after the selloff, FANG stocks continue to trade at higher valuations than the broad market. Netflix trades at a P/E of 210 and Amazon.com trades at a P/E of 327. Facebook and Google-parent Alphabet, both of which have been directly linked with privacy concerns, now trade at valuations near 52-week lows.

The overhang of increased government oversight has sunk the fortunes of large technology companies in the past. Microsoft Corp reached a settlement in an antitrust case with the Department of Justice in 2002 that lasted until 2011, contributing to a long period of underperformance that kept the stock below the high it reached in 1999 until 2016. Since then, the stock is up nearly 60 percent on the strength of its cloud-based services.

Margaret Patel, a senior portfolio manager at Wells Fargo Funds, said that she has been adding to defense stocks like Raytheon Co that should benefit from increasing military spending in both the U.S. and overseas. At the same time, she is increasing her exposure of non-FANG technology stocks like Adobe Systems Inc and Microsoft that have been hurt by the recent sell-off in the sector.

"It's very hard to see another sector that still has all the fundamental drivers for growing much faster than any other sector," she said.

Reporting by David Randall; Editing by Jennifer Ablan and Nick Zieminski

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