What Happens When Big Tech Trips Up?
Regulatory, legal, and financial scrutiny suggests that the market's over-reliance on Big Tech requires additional caution.
Happy Tuesday! Hope you all had a good holiday weekend. Welcome to our first edition of Business As Usual, a digest for ‘deep thinks’ at the intersection of finance, culture, politics, and all that falls in-between.
If there’s anything that can be said about 2020, it’s that these times have such great dissonance. More than 8% of the country is unemployed, hundreds of thousands of small businesses are closing permanently, and the stock market has been rallying to all-time highs — one is unlike the other. In short, these last few months have shown us just how temperamental the markets can be.
After the March COVID-19 correction, stocks fell dramatically. In the month of March, the NASDAQ fell over 37% from its peak to its trough. However, stocks slowly recovered after the CARES Act stimulus bill passed. Concurrently with the passing of stimulus, a swath of new retail investors (mostly bored folks under stay-at-home orders) entered the markets. They jumped on perceived deals in travel, precious metals, and potential vaccine makers. In the months ahead, investors started to realize that the impact on various segments of our economy wasn’t so bad — and as a result, money started piling back into equities. One sector got more love than the others, though — tech. This sector is notably not a place for deals or fundamentals-based trading. So what does that mean?
Say that you go into a store and see something which regularly retails at $5 being sold ‘at a discount’ for $6. The suggestion is laughable; anybody who knew the true value of that shirt would recognize that paying more than the market value for it would be ridiculous. However, that describes what’s going on with tech in the markets right now — people see stock splits and perceive a buying opportunity; investors chase the volatility for ‘short-term’ trades; monolithic financial institutions turn the markets into their playtoy. What people fail to understand is that several companies are that $6 shirt — they’re propping up the perception of a ‘boom’ in markets, but are already trading at some of the steepest price premiums we’ve seen in recent history.
For instance, the top 10 stocks in the NASDAQ 100 index represent over 57% of its weighting. The NASDAQ 100 and the S&P 500 share a lot in common — at least more than its neighboring colleague, the Dow Jones Industrial Index. (We’ll save this comparison for another article.) Many of the biggest companies in both the S&P and NASDAQ indices are tech companies like Apple, Microsoft, Amazon, Facebook, Alphabet (which owns Google), and Tesla. These companies have different weightings in America’s biggest indices, but the overlap alone paints the picture of America’s market reliance on the performance of Big Tech. A selloff in any one of these stocks is sufficient enough to dampen index gains — and it could come in the form of threats from litigation or price movement from a political or economic event like an index addition.
To an outsider, this reliance might appear healthy at first glance — after all, these are some of the biggest and most visible companies in the United States. However, households and retail investors are likely unaware of just how much of an impact these stocks have on the markets. Most households just trust that the allocations they select for their accounts is going to pan out gains.
Ultimately, as Big Tech grows and becomes more valuable, the weighting of the sector in these funds grows as well. The fund managers are made to buy more of the stock at the current price premium, which trickles down in incredibly meaningful ways—many households hold exchange-traded funds and passive funds which mimic the weightings of these indices in their 401(k)s, IRAs, 529s, and other accounts. In fact, almost half of the money in stocks is now on ‘autopilot’ in these funds. That’s cause for concern.
We’ve already established that many of these companies already trade at considerable premiums (you can evaluate the valuation of a company using a number of methods, but a tried method is using the price-to-earnings ratio.) The premium tells us that many investors are optimistic about sustained growth in these companies, or maybe it’s just a residual of volatility in these stocks — but we’ll never know. Regardless, the former point offers a question: should investors be so optimistic given the increased prevalence of political, financial, and legal incursions into their business?
Times have changed and Washington looks to be putting its relationship with Big Tech on the rocks, even as they accept their millions in campaign contributions. Unlikely alliances have formed among the ranks of both major parties in an effort to counter Big Tech’s influence. Many members of the plurality have their unique gripes about the influence of these monolithic companies. For conservatives, there are concerns about ‘liberal bias’ and censorship of the discourse on social media sites. For liberals, there are concerns about data privacy, regulation, and political influence. There are plenty of other parties who are wrapped up in this, which are best described in the mid-body of this excellent 2019 article by Alexis Madrigal for The Atlantic.
In July 2020, the CEOs of major tech companies agreed to meet with lawmakers at what has now been deemed the ‘Big Tech Antitrust Hearing.’ It was not the first time that lawmakers had summoned Big Tech to The Hill, but it was the first ‘family affair’ so to speak. Just a month later, TikTok—arguably the stand-in representative for Big Tech of China—was given an ultimatum by the Trump administration to sell their app. This came on the heels of alarmists on The Hill suggesting TikTok was a ‘digital weapon for the Chinese government’ and that it was actively ‘spying on our children.’ Weeks later, Epic Games sued Apple and Google after seeing its popular game, Fortnite, removed from the App Store because of their decision to process payments in a way which violated Apple’s terms and conditions. Apple filed a counter-suit on Tuesday. Google is also prepping for an antitrust-related battle with the Department of Justice.
It goes without saying that cracks are forming in the foundation of the formerly rock-solid relationship between Big Tech and The Hill. It’s likely that if this relationship continues to sour, The Street is apt to feel (or price in) the unsettling tension. Let me be clear, I don’t think that the breakup of any of these major companies is coming anytime in the near-term. The actions of Congress, the current administration, and many state governments are likely for show — at least for now.
That’s because the reality is that nobody wants to be the one who pulls the trigger on any of these companies, making them break up or restructure. That would have disastrous side effects on U.S. markets, which would surely be brought up in every future campaign against them— \”Oh, they destroyed your investments and 401(k) by breaking up [company],” … “So-and-so destroyed thousands of jobs by flexing their aggressive [insert a political ideology] agenda over this country!”
Constituents can be sold on the disruption of services having a concrete and real effect on their residual savings and investments. People are sold on the stability of the nation, but the antitrust investigations are notable in the sense that if anyone pulls the trigger, they might have a proportional affect on market. On the flipside, it might offer something unprecedented — an opportunity for the economy to flourish. Well, at least until these companies get back together by buying each other.
So what are some takeaways from this?
Maybe it’s time to consider that the classic ‘index ETFs’ are no longer safe havens for big gains. They might even be shaky ground for capital preservation. If you need any sources, go look at the relative volatility of these ETFs during the last few corrections: it’s not pretty. Many index funds have cemented themselves firm in the position that value companies are going to be the gainers. I’m not too confident about that anymore, especially in $SPY (which tracks the S&P 500) and $QQQ (which tracks the NASDAQ Composite). However, these funds follow at the whims of the selection committees for their respective funds—so it’s more on them (a discussion we’ll save for some other time.)
I would afford some caution to tech stocks which are taking on extra helpings of regulatory and legal scrutiny. I’d also afford caution to those who are presently ‘double-dipping’; say you own $SPY and $QQQ—you are getting a considerable overlap of stocks and heavy-weight companies between the two. You don’t need to own Google or Apple twice. Go buy something more useful.
If you’re weary of holding funds which are overweight on Big Tech, maybe it’s time to cash out and move to a fund chasing both value and growth companies. Consider buying a heavily diversified index fund which tracks something like the Russell 3000 or the S&P Composite 1500.
The alternative to an index fund is a fund which tracks the performance of an industry. Recently, there has been an increase in ‘thematic ETFs’, which have performed extremely well this year. There are funds for marijuana & CBD, sports betting, self-driving car technology, and early-stage clinical biotech companies. You can really get as niche as you want, so do your research and find what’s out there.
The question proposed in the headline is: “What happens when Big Tech trips up?” It isn’t “what will happen if it does.” That deserves distinction. It’s incredibly unlikely that any of the ‘Big Tech giants’ are going to wash up soon, but there are few companies which last forever. If you believe Big Tech will continue to get larger; that it will overwhelm political systems and their ability to cope with corporate influence (and it’s possible it will), then you have effectively written the bull case for companies like Twitter, Google, Apple, Facebook, and the like.
However, knowing the nature of politicians to vigorously pursue a scapegoat or common enemy makes the former situation less likely. In fact, it makes it impossible—the antitrust investigations and lawsuits from aggressive competitors will bear fines, but it’s too early to say what other effects might exist. If these companies hold on to their positions as heroes of The Street, these effects might affect every American; our markets; our economy at large.
These companies know now that there is plenty to lose. It’s bizarre to me that investors haven’t realized the same.
shorting tech. brb