WTF Just Happened To Facebook?

Sorting through the mess for portfolio implications.

As I write this at 7:30pm ET on Wednesday night Facebook (FB) is down 20% in conjunction with a poorly received earnings report that missed estimates slightly, a conference call that Todd Harrison said included several uses of the word "deceleration," some bad news from China a little earlier and a general villagers with pitchforks sentiment over content that is allowed on the platform and content that isn't.

Thinking it was still down 25% I tweeted;

That drew a comment about the decline being unjustified and I added "no idea, maybe it should be down some big amount to then try to rebuild from but 25% for anything, other than a Union Carbide in Bhopal India if you remember that one, seems like too much."

People have a love hate relationship with Facebook which will not be news to anyone. In a lot of ways it is frustrating to use but speaking personally it has allowed me to connect to a lot people from previous chapters of my life and I like maintaining those contacts. It has taken on a ubiquity that seems unlikely to abate and they have figured out a way to monetize itself somewhat effectively. Obviously it also has whatsapp which if you've every used it comes in handy and Instragram which seems like more of an enjoyable experience although I personally don't feel like I connect as well on it, I just like looking at other peoples pictures of stuff that is similar to what I post pictures of (fire trucks, motorcycles, trophy trucks, national parks and sports related). This paragraph is not an argument to buy it as an individual holding it is an argument that it is unlikely to go to zero at least for now. I made a wise crack above about it not being a Union Carbide in Bhopal situation which I don't think it is. While I do believe the decline to be excessive it is not my discipline to guess how the market react to some extreme decline so again, not going to do that.

Eric Balchunas tweeted the following table showing the weighting Facebook has in various ETFs as follows;

Before diving in, the 42% in HSPX appears to be an error. The fund tracks the S&P 500 with a covered call overlay. ETF.com shows the fund having about a 2% weighting in Facebook (pre-earnings report) which makes more sense. This entire episode plays into something I write about all the time related to looking through to the holdings of any funds you use to understand what they own.

The list in the table is primarily a mix of broad based tech and narrow based (thematic or niche) tech. Someone mixing broad based funds, narrow funds and individual stocks could have more FB than they bargained for depending on how everything is sized. If FB had a 2% weighting in the S&P 500 before the earnings report and all in you have 6% in your portfolio, then you've made a huge bet. A portfolio with 6% doesn't have to be terrible, even considering the decline, if that exposure is known. In that instance it is essentially a bad trade but even then maybe not as the stock is up so much in the last few weeks, you might just be to where you were in early May which is a bummer but not financial plan altering. Someone who did not realize they had that much exposure might be upset, even to the point of panic selling. After all, someone is selling after hours.

Lets work through some numbers using one broad based fund and one niche fund.The SPDR MFS Systematic Growth Equity ETF (SYG) kind if sticks out. It is an actively managed fund and although the ETF.com page doesn't say so, it seems like it could be thought of as a multi-factor fund. Even if you disagree with that, it is a broad based equity fund with 39% in tech (anything above 30% is a caution light I write about all the time) and FB is (was) the largest position by far (assuming Bloomberg and ETF.com are correct) at 7.12% (assume all numbers from here on out are pre FB earnings report). As a broad equity proxy, similar to the SPDR S&P 500 (SPY) there might be accounts out there for which SYG is the sole equity exposure, maybe paired with one fixed income ETF. A portfolio with the right 2 or 3 funds can be a valid way to go.

Based on what we know tonight, someone whose only equity exposure is SYG is looking at a 142 basis point drag from SYG's previous weighing to FB. If the decline follows through, then there are other names that could go down in sympathy with FB and maybe weigh further on the fund. These are not numbers that should induce panic. I would reiterate the point that it is crucial to look through to fund holdings but this sort of decline could be mostly if not entirely retraced in less than a week.

If you own SPY in the same context then you are confronting a 40-50 basis point decline plus any sort of sympathy decline. What if you had 80% in SYG and allocated the other 20% to one theme (on its face not crazy, more than I'd want in one theme but people do this) but the one theme was Social Media and the Global X Social Media ETF (SOCL) which had a 12% weighting to FB. Even that is not catastrophic even if it does create a bigger hole to dig out from. Quantifying FB's impact for the 20% drop as it now stands works out to the SYG/SOCL 80/20 equity combo having a drag of 1.61% although if the decline persists into Thursday then SOCL is more prone to sympathy selling than is SYG.

Today's post originally was going to be about how much money is enough money prompted by this post from White Coat Investor. A related question then is how much do you need in individual stocks and how are you going to size them? I write all the time about starting out with stocks at 2-3% weightings. I've had plenty of comments over the years disagreeing with that approach which is fair game but to me, that is how you manage against being wrong. Whether you're talking about stocks or funds, if you go narrower than SPY, I do, then you will get some wrong, that will go with the territory. If that is unacceptable then you should not go narrower than SPY or any of the many other broad based funds out there. And FB may not be wrong, this might just be a set back like in the spring that shook out some weak hands and then went on to a new high.

I don't feel the need to try to predict from the bottom up what comes next, I merely made the observation that the 25% decline seemed excessive based on things I have seen in my career but again I am not a buyer on the news, this post is more like don't freak out if you have a lot of exposure, I don't think it is going to zero, and if you are not impacted by this blowup in a meaningful way there will be ones where you are impacted in a more meaningful way and this episode with Facebook could serve as one of countless examples for this sort of thing.

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