Cyber Security Stocks Can't Hack Rally With $700 Million Erased

  • Five-year-old network security index down 15% in 2016
  • ETF tracking the gauge has seen market cap cut almost in half

Investment in cyber-security companies has been anything but safe in 2016.

In the U.S. stock market, a five-year-old index tracking network security firms has slipped 15 percent in 2016, more than double the loss for the Standard & Poor’s 500 Index. Price declines and investor withdrawals have halved the value of an exchange-traded fund tied to the shares after swelling to a record $1.4 billion in July.

Companies from CyberArk Software Ltd. to FireEye Inc. surged in popularity last year following a spate of high-profile security issues, including the breaching of confidential government employee records. As market priorities shifted to economic concerns like weak crude oil prices and slowing growth, investors have lost their taste for one of last year’s most popular investments, according to Michael Ball of Weatherstone Capital Management Inc.

“Since there’s a shorter track record for the cyber-security firms, people have become more hesitant,” said Ball, president and lead portfolio manager of Colorado-based Weatherstone, which oversees more than $1 billion. “We’ve also seen a narrowing in market breadth across industries as investors have gotten more defensive. Not to mention there have been fewer high-profile cyber-security attacks lately.”

It’s not just a few companies dragging the ISE Cyber Security Index lower. Thirty-three out of the gauge’s 34 stocks have fallen this year, with FireEye and Barracuda Networks Inc. the biggest decliners, losing more than 32 percent. The gauge slid 0.3 percent at 4 p.m. in New York.

Breadth is nothing unusual for the index, whose companies have historically moved in tandem in both directions. From the start of 2015 through June 23, when the gauge surged 28 percent to a record high, all but seven companies climbed more than 3.4 percent.

“It’s a fledgling industry, so you’ll have higher volatility and less distinction between the companies,” said Ball. “Things will continue to be painted with a pretty broad brush.”

Options traders are signaling that the pain may continue for cyber-security stocks. Ownership of bearish options on the PureFunds ISE Cyber Security ETFis at the highest level relative to bullish contracts since July, according to data compiled by Bloomberg. Further, short interest on the ETF is close to the highest since the fund was originated in November 2014, Bloomberg and Markit Ltd. data show.

The ISE Cyber index’s sharp gains in the first half of 2015 resulted in stretched forward valuations for the gauge, and investors are now paring that back by selling, according to Ball. The median stock in the ISE Cyber index still trades at 20.2 times analyst earnings estimates, data compiled by Bloomberg show. The multiple compares with 16 times forecast income in the S&P 500.

“People are less willing to take the higher degree of risk associated with higher P/E ratios,” said Ball. “Especially right now, in the face of strong headwinds in the overall market.”

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