Technology Gets De-FAANGed
Technology mega caps, including Facebook, Apple, Amazon, Netflix and Google (FAANG), are enjoying an unprecedented market run. As they continue to push the boundaries of market power, we believe the potential for major US regulatory action becomes more likely, if not in 2020, then in the relatively near future.
Three major issues are placing technology firms in regulatory crosshairs. Antitrust is clearly the first as exemplified by European regulatory action against Google and resultant large fines. Second is taxation, as countries target the technology giants for new taxes because of the disparity between their prominent role in consumers’ lives and minimal local tax obligations. Third is the issue of the ownership of digital assets and privacy, as evidenced by the Facebook-Cambridge Analytica affair, which drew regulatory attention to the acquisition, use and commercialization of personal user data. Interest from regulators has increasingly called leaders of the technology giants to Washington DC.
The likelihood of antitrust action depends in part on how the regulators describe a monopoly. Antitrust regulation which broke up the early-twentieth century monopolies (such as Standard Oil in 1911) was founded on market structure – that is, the domination of a company within the business ecosystem. The concentration of power mattered more than consumer satisfaction in the early days of antitrust regulation. In the 1980s, the description of a monopoly substantially shifted from market dominance to consumer wellbeing. US antitrust regulators began evaluating consumer pricing, satisfaction and overall welfare to assess monopoly power. Consumer wellbeing has been the lens used for antitrust action for the last 40 years.
The regulatory attitude may be reversing to address the growing dominance of the technology mega firms. Although consumers may enjoy the services, the economic power of these firms is undeniable. The US Department of Justice uses the Herfindahl-Hirschman Index to measure market concentration, using 25 as a baseline for action. Internet retailing carries a Herfindahl-Hirschman Index value of more than twice that number (53), reflecting the handful of companies selling products online and running much of the cloud computing environment. Interactive media and services (Herfindahl-Hirschman Index value of 46) may also be vulnerable to regulatory action.
We do not see risks of a new regulatory environment being priced into today’s market valuations. Historically, valuations have declined once a regulator acts based on expectations of lower profit margins and/or restricted growth following a resolution. Technology stocks tumbling would be a negative event for equities overall in the very short run as investors reset their growth expectations especially given the fact that FAANG stocks alone have accounted for more than one quarter of the 190% in cumulative return of the S&P 500 Index since 2012.
Investors may underweight FAANG stocks while revising their expected returns from these stocks. Also, in this scenario, rotating toward value stocks in the US since the FAANGs have significantly contributed to the outperformance of growth stocks; looking for companies enhancing productivity through technology; and buying developed market international equities (where valuations are already low on a relative basis) may prove to be useful strategies in our view.