Why regulatory fight back means Big Tech has peaked

WP has teamed up with Forstrong Global CEO and CIO Tyler Mordy for a weekly series highlighting and analysing seven macro super trends for 2021. In part one, he explained why a fiscal revolution is here, while, for Super Trend 2, he analysed the inflation landscape and its investment implications. In part three, Mordy delved into the low bond yields and the subsequent 'income famine' and, here, for Super Trend 4, he examines the state of Big Tech.

Emotions play a huge role in our life choices. From our romantic partners to the favourite pants that get worn long after they should be seen in public. Investing is no different. Just like those pants, it’s tough to rotate out of your favourite stock or sector, especially ones that have treated you so well for so many years.

But that’s where we are with Big Tech, according to Tyler Mordy, Forstrong CEO and CIO, who believes that its long period of investment leadership that began all the way back in 2009 is now over.

Silicon Valley’s scrappy attitude of “move fast and break things” is also over. On the surface, this approach has been about testing new ideas, iterating quickly and aiming for more frequent points of learning. But don’t be fooled, the overriding philosophy is simple: more is always better. More clicks. More downloads. More eyeballs. And faster — anything less than warp speed is unacceptable.

Yet, a rich irony is emerging. It turns out regulators, too, can move fast and break things. Anti-trust regulators have caught up with this ethos – and they have a history of overshooting.

The first significant shot across the bow for the tech industry came on October 20, 2020, when the Department of Justice sued Google parent Alphabet for anti-competitive conduct. The lawsuit claims that Alphabet’s payments to Apple Inc. to make Google its default search engine contravenes US law. Alphabet remits some USD $10 billion annually to Apple for this privilege.

Then, in December, Facebook was sued by the Federal Trade Commission and 48 state attorneys-general for anti-competitive practices. The key allegation here is that Facebook’s purchases of WhatsApp and Instagram were strategic targets to neutralize their respective threats and entrench its own position as the dominant social networking platform. 

Mordy said: “But these individual cases are really about a much bigger issue: a shift in the regulator’s worldview. Increasingly, they view Big Tech through a different world lens — not as individual companies operating in efficient markets, but as winner-takes-all monopolists abusing their power.

“This reflects a deeper understanding of Big Tech’s business models, where the preferences, exchanges and interactions of users are monitored, leveraged and ultimately pushed and promoted across business lines through behaviourally-targeted algorithmic methods.

“Looking ahead, regulators show no signs of slowing down. And why should they? The pandemic has hyper-charged the world’s movement to digitization. Data, not oil, has become the lifeblood of the modern economy. Google, Facebook and Amazon now account for some 70% of online advertising globally. There are legitimate concerns that Big Tech will stifle innovation and continue to swallow younger competitors.”

Of course, more regulation means lower profits - and this is not just an issue confined to America; this Super Trend is global. Take China, for example, where regulators have huge plans to create a “new normal” for its tech giants, including an attempt to define anti-competitive behaviour in the sector by targeting the likes of Tencent, Baidu and Alibaba.

Beijing's power game against the tech giants has just begun, Mordy added, and this is being reflected in market prices. Whereas before Chinese tech may have been seen as a better investment than their U.S. FAANG counterparts, which faced more anti-trust attention, now that regulation has spread globally.

Since 2009, Big Tech’s dominance has seen the companies grow into massive monopolies perceived by many to have abused their power. China wants to rein them in and the market is increasingly discounting this risk factor: China’s technology companies have been underperforming this year.

This sentiment is also reflected in Europe, where a U.K. competition watchdog has launched its first ever anti-trust investigation into Apple, alleging that the company is abusing its power as the gatekeeper of the App Store. Apple recently announced it will lower its fees on apps from 30% to 15% of revenue.

The investment issue, Mordy says, is that “Big Tech is now a very crowded trade”. The majority of both retail and institutional portfolios are overweight Big Tech. Yet Mordy and his investment team no longer believe this stance is the right one for the period ahead.

He said: “Global asset allocators should be questioning this position. We believe a regime shift has already started and Big Tech is now set to underperform for several years.”

The period from 2008 to 2020 featured secular stagnation, low growth, low inflation, and private sector deleveraging. This growth famine meant that any company that could tell a story of growth commanded a premium. Now, Mordy argued, as we enter into a period of higher global growth,  the optimistic forecasts priced into Big Tech become more challenging.

So what should investors do? Forstrong believes it’s time to start rotating into sectors that can attach themselves to higher growth going forward like financials and industrials, for example, which are under-represented and under-valued in global stock markets. Equities outside of North America – markets which do well when growth is higher -- are also primed for a long period of outperformance.

Mordy explained: “It’s time to take a clinical view of Big Tech. There are serious macro headwinds. If investors can remove themselves from the headlines and ambient noise, another story emerges.

"The reality is everyone is in on the Big Tech trade. This is not the bubble of the late 1990s. But expectations are high and valuations are very rich. The FAANGs recently accounted for more than 20% of the S&P 500’s market cap. Apple alone commands a bigger weight in the MSCI World equity index than any other single country apart from the US and Japan.

“A related issue is that several companies have tried to get in on the party, positioning themselves as tech unicorn plays. Through a combination of clever marketing and the willingness of shareholders to look the other way, many of these companies have, to put the most charitable spin on it, inflated expectations. Perhaps a company that straps an iPad to a stationary exercise bike should not have a market cap of over $60 billion dollars?

“But it is the regulators who will throw a big stick in the spoke of Big Tech’s business model. Future acquisitions will face far more hostile scrutiny. Some of the incumbent tech giants could even be forced to breakup. In almost every way, tech companies will face a far more adverse regulatory environment over the coming years. The air has already started to go out of the most overstretched valuations. But there is plenty of room for further deflation — and for things to be broken.”

Maybe it’s time to look closer at your Big Tech exposure – and those favourite pants of yours – and rotate into something more befitting this new era of global growth.