The year big tech stocks fell from glory

For the better part of the previous decade, investors crowded into shares of fast-growing technology companies whose strong gains year after year reinforced bets that they had nowhere to go but up. Surging prices for such stocks as Facebook parent Meta Platforms Inc., Amazon.com Inc., Apple Inc., Netflix Inc. and Google owner Alphabet Inc. propelled major indexes to dozens of new highs.

The trade became so popular, it earned its own acronym: FAANG.

The music stopped last year when the Federal Reserve’s aggressive interest-rate increases shifted the momentum. Investors were forced to reassess the pros and cons of holding the shares of firms whose appeal centered on their potential for generating windfall profits many years in the future.

“When money is basically free…you’re willing to place a high value on future earnings, particularly of growth stocks,” said Erik Knutzen, chief investment officer of multiasset strategies at Neuberger Berman. “That all changes when rates rise.”

Meta plunged 64% in 2022; Netflix declined 51%; the other three stocks dropped at least 27%. Together the FAANG stocks shed more than $3 trillion in market value, helping drag the broader stock market down with them. The S&P 500 sank 19%, its worst year since the 2008 financial crisis.

The reason big tech stocks receive so much attention? The S&P 500 is weighted by market value, so the largest companies in the index have the greatest sway over its direction. Even after last year’s bruising declines, the five FAANG stocks have a 13% weighting in the index,down from about 17% at the end of 2021, according to S&P Dow Jones Indices.

Put another way, a basket of megacap-tech companies that includes the FAANG stocks, along with Microsoft Corp., Nvidia Corp. and Tesla Inc., was responsible for more of the S&P 500’s 2022 declines than all the other components combined. That is according to a Bespoke Investment Group analysis.

When interest rates were near zero, investors were more willing to pay up for growth stocks and risky assets in their search for higher returns. But with the Fed raising rates at the fastest pace since the 1980s, the market environment has turned to favor investments that generate cash for the holder now.

Investors are reaching for inflation beneficiaries and safety plays, the relative outperformers in last year’s rocky market conditions. The S&P 500 energy sector rallied 59% in 2022 as geopolitical strife sent oil prices surging in the first quarter. Shares of utility, consumer-staples and healthcare companies—known as defensive stocks that tend to be steady no matter the market conditions—outperformed the broader index.

“During the pandemic, technology stocks became the darlings and became overvalued,” said Gina Bolvin, president of Bolvin Wealth Management Group. In 2022, “value came back in style.”

That rotation led to a reshuffling of the stock market’s leaderboard. Tesla, for example, entered 2022 as the fifth-biggest company in the S&P 500 and finished as the 11th-largest. Meta was the sixth going into the year and fell to 19th. Exxon Mobil Corp., meanwhile, didn’t crack the top 25 at the start and ended the year in eighth place.

As consumers and businesses tighten their belts to brace for a potential recession, tech companies that had appeared immune to the economic woes of the pandemic have seen their revenue slow. Companies such as Microsoft reported their worst quarterly results in years. Amazon and Meta announced layoffs.

“For tech and communication services, there was this belief that those revenue streams were impervious to the ups and downs of the economy,” said Zach Hill, head of portfolio management at Horizon Investments. “Investors have to reckon with that.”

Mr. Hill said his firm was overweight energy shares last year and favored value stocks, those deemed by investors to be trading below a measure of their worth. The firm continues to have a preference for value-oriented investments and remains cautious on megacap tech stocks, he said.

Even after tech stocks’ drawdown last year, the sector still appears pricey compared with the broader market. The stocks in the S&P 500’s information-technology sector are trading at roughly 20 times projected earnings over the next 12 months, according to FactSet. Meanwhile, the broader index has a multiple of around 17.

Still, the outsize market influence of Big Tech is unlikely to change soon, strategists and investors say, barring another few years of 2022-like performances. That means the broader indexes could remain under pressure as long as megacap tech struggles.

Eric Sterner, chief investment officer of Apollon Wealth Management, said his firm trimmed its tech exposure in 2022 and leaned on healthcare, utility and energy stocks. He said he thinks tech could reign as the market’s leader again when the Fed begins to cut interest rates, which he predicts will likely happen in 2024.

“Once we set up for recovery, I expect those tech companies to reassume their leadership position because they are the most innovative companies out there,” he said.