In my April column for Professional Planner, I warned of a possible scenario that could bring to a grinding halt the hitherto unassailable leadership of America’s technology stocks. As lower prices have ensued more recently, much as expected, we ask whether they might now be cheap enough to provide an opportunity for the patient, value-oriented investor.
A combination of record high share prices and a seismic shift in the social and political narrative around tech names, plus the concentration of technology issues held by passive index funds put the ingredients in place for a potential de-rating of both earnings expectations and earnings multiples. That’s a double whammy for tech names, whose earnings have been growing fast and share prices even faster.
We reported that FANG+ multiples were three times higher than the broader market, that just eight stocks were responsible for 50 per cent of the Nasdaq-100 Index, and that while the S&P 500 had advanced a phenomenal 331 per cent in the nine years since the 2009 lows, Amazon was up over 2100 per cent, Apple more than 1100 per cent, Netflix 5300 per cent and Google 586 per cent.
Meanwhile, we listed examples of the growing shift in sentiment against large tech names: Mark Zuckerberg and Facebook remain ensnared in an investigation into Russian-backed election interference; the European Union fined Alphabet’s Google €2.4 billion for abusing its dominance in search and ordered Apple to repay €13 billion in allegedly unpaid taxes to Ireland. Facebook was fined €110 million in May 2017, for misleading the EU during a review of its acquisition of messaging unit WhatsApp; the EU ordered Amazon to pay back €250 million in allegedly unpaid taxes to Luxembourg; and in January this year, Qualcomm received a €997 million antitrust fine for allegedly illegal payments to Apple to ensure its only its chips were used in Apple devices.
Perhaps most importantly, the US Democrats, who arguably lost the last election to Trump for cosying up to big business, are returning to their roots with a new economic agenda called A Better Deal. The section of ‘A Better Deal’ titled “Cracking down on corporate monopolies and the abuse of economic and political power” is focused entirely on antitrust enforcement and merger law, the most important but arguably weakest component of America’s competition policy. This follows a US Senate Judiciary Committee’s Subcommittee on Antitrust, Competition and Consumer Rights hearing that examined the “consumer welfare” standard that is the bedrock of antitrust enforcement, with some arguing that antitrust actions would be better framed and served if the measure was economic and political power rather than consumer prices.
A shifting narrative and the associated emergence of regulatory risk has caused investors to reassess their assumption of indefinite double-digit growth, capping prices as a result.
As of this writing, Alibaba is 29 per cent below its high price, Facebook is down 39 percent, Amazon is down 26 per cent, Apple and Google are both 20 per cent lower, Twitter 32 per cent lower and Netflix 36 per cent below its highs. In anyone’s language, this is a crash.
In the last month or so, almost a trillion dollars has been wiped off the combined valuations of Alphabet, Apple, Netflix, Facebook, Amazon, Microsoft, and China’s Alibaba and Tencent. The question now is how much further has the tech collapse got to go?
The narrative against big tech appears to be heating up. Facebook has revealed it will allow French regulatory staff to embed themselves within the company to monitor its policing of hate speech. Just as recently, the US Representative-elect for New York’s 14th congressional district, Alexandria Ocasio-Cortez tweeted: “The idea that [Amazon] will receive hundreds of millions of dollars in tax breaks [for locating its new headquarters in Long Island City, Queens] at a time when our subway is crumbling, and our communities need MORE investment, not less, is extremely concerning to residents here.”
Meanwhile, we are keeping a close eye on the US corporate bond market, where investors are losing enthusiasm and demanding higher returns for the risk. Investors need little reminding that, while lower interest rates and the injection of liquidity through quantitative easing helped elevate asset prices, rising interest rates and the removal of liquidity through quantitative tapering cannot do the same. You cannot have it both ways. Higher rates and QT must depress asset prices.
We are keeping a close eye on the fundamentals of many of the tech names and it is important to ask whether prices are already factoring in the worst. Keep in mind, prices often hit bottom well ahead of the fundamentals improving.
As owners of Facebook, we are monitoring earnings, which missed consensus expectations in the second quarter, and we are also cognisant of reports that roughly a quarter of the social media giant’s US users deleted the app following the Cambridge Analytica scandal.
Investors should be aware that an Amazon employee revolt resulted in an increase to its minimum wage to US$15 ($20.70)/hour, while Google’s offshore revenues are worth less amid a rising US dollar. Meanwhile at Netflix, global subscriber growth rates are slowing, which is combining with a need for greater investment in content production due to intensifying domestic competition – resulting in negative cash flow. Elsewhere, Apple’s slowing pace of innovation is reportedly one of the reasons competitors’ products are catching up in features and functionality; when combined with their under-pricing, this is resulting in users upgrading their iPhones at a slower rate.
I have previously quoted George Washington, who wrote: “It is in the very nature of power that it will expand until it is checked by an opposite power.”
Whether we are talking about Amazon, Netflix, Google, Apple, Facebook or Airbnb, investors must always remember that markets swing from extreme bouts of pessimism to equally extreme bouts of optimism. Even the biggest and most profitable companies in the world cannot grow profits at uninterrupted double-digit rates forever.
Eventually, whether it’s the self-inflicted prioritisation of short-term profit maximisation at the expense of long-term investment in innovation, or whether it is the exogenous force of a social or political backlash, company profits inevitably stumble.
When that stumble coincides with ultra-high share price multiples, investors need to watch out. Red October, as the sell-off last month is now known, has popped the bubble of invincibility around the tech names that dominate the indices. For example, Bloomberg shows Facebook’s adjusted earnings growth is now estimated to slow from 20 per cent in 2018 to 5 per cent in 2019; Google parent Alphabet’s is expected to slow from 19 per cent to 6 per cent and Amazon’s from 173 per cent to 32 per cent.
While it remains possible that passive indices may need to rebalance if retail investors panic, forcing them to sell stocks down even further, serious investors need to be on the lookout for opportunities now.
If one believes these companies will continue to dominate life on earth for at least the next decade, any overreaction on the downside should be thought of as an opportunity, rather than risk. The only step remaining is for investors to determine whether the worst has already been factored in.