Head of Equity Strategy
Summary: Facebook shares are lower but not by a lot relative to the overall technology sector despite yesterday's FTC lawsuit against the company aiming to break-up the social media giant. Investors for now seem confident that the government has a bad case and that the evidence of wrongdoing is thin but the FTC lawsuit fits into a bigger narrative of rising technology regulation on both sides of the Atlantic. Uncertainty on how regulation will impact profitability is still high but investors need to pay attention because it could change the entire technology sentiment in 2021.
Facebook shares were down 2% yesterday as the FTC (the US Federal Trade Commission) together with 46 states filed an antitrust case against the company for choking competition. The short version is that the objective of lawsuit is to break-up Facebook’s Instagram and WhatsApp businesses into separate entities. Facebook’s main defense is that the very same FTC has approved both acquisitions. The fact that WhatsApp is not being used commercially to make money yet so many years after the acquisition is used as an example as an acquisition made not for commercial reasons but only to quell competition. Facebook likely knew about this angle in its defense as it recently presented a plan for monetizing WhatsApp.
Facebook is arguing in the case of Instagram that there was no evidence that Instagram would be big stand-alone and that it became big because Facebook invested a lot of money into development. The fact that the shares were only down 2% indicates that investors believe that the US government does not have a strong case yet and that the case will take years in court while Facebook grows profits even more before maybe a settle with the government. Shares are down another 1% in US pre-market session. If Facebook’s business is broken up it would be a big blow as Instagram generated $20bn in revenue in 2019 and thus account for almost 30% of the overall business in addition to being a key driver in the future growth of revenue. While WhatsApp is not generating meaningful revenue for Facebook it is a potential future revenue driver.
The case against Facebook follows a recent antitrust case against Google and new regulation by Beijing to unlock more competition in the Chinese technology sector being quelled by the major players such as Alibaba, Tencent and Baidu. And today, Financial Times is writing about a new EU draft regulation on big technology companies operating in the EU. If a technology platform has more than 45mn users, it will now be catagorised as a systemically important technology platform which will have special obligations to shape information flows. Failing to comply with the new rules could end in fines of up to 6% of their annual turnover. No matter where you look regulation and rules will be applied against the biggest technology companies in the coming years. The main question is how it will impact these companies’ profitability and growth trajectory. It will never be a binary outcome so investors will have time to adjust valuations accordingly.
The case for a very different year for technology stocks
Technology regulation depending on the size and speed next year could begin to impact investor sentiment and valuations of the large technology companies. This could hold back main technology indices, but even more scary is the large pocket of smaller technology companies with very elevated valuations. DoorDash which started trading yesterday is a good example as it is valued at twice the EV/Sales ratio than that of its Chinese counterpart Meituan which is seven times larger on revenue. The high valuations of technology companies are a function of the growth profile, high risk-reward ratio, lower variance on earnings but most importantly low discount rates which inflates high duration (high growth companies with cash flows far into the future) assets.
However, with signs of cost pressures on logistics costs across shipping and last-mile delivery on top of rising food prices and elevated industrial metals prices the potential input costs are rising throughout the global supply chain. The missing piece is higher energy prices which could come if, as we believe, the vaccine rollouts happen much faster than expected. That would create a powerful input cost shock to the system and force the US 10-year interest rate far above 1% and with it pressure on high duration assets such as US technology stocks. We have said before on our morning podcast that the 1% threshold remains our trigger point for calling the big rotation on value vs growth stocks. And if it happens it will be interesting to see how the new influx of retail investors overweight technology stocks react. There are indeed many paths to an interesting 2021 in equities.
AI: The good, the bad, and the bubble
While a deep recession may not be iminent thanks to central bank policy, interest rates will have to stay high for longer, and this will be accompanied by volatility risk from the unwinding of bubbles, especially within AI.
Steen Jakobsen,
Chief Investment Officer
The emergence of advanced AI systems is by far the most surprising event this year, turning everything upside down, while risks and benefits are debated. AI will also become an arms race between the US and China.
Peter Garnry,
Head of Equity Strategy
As China navigates global fragmentation, its cycle of technology application, productivity enhancement, and growth is threatened by US breakthroughs in generative AI, limited computing power, and geopolitical tensions.
Redmond Wong,
Market Strategist
Japan’s expertise in semiconductors and robotic integration could be the foundation of AI dominance. Combining two of this year's themes, Japanese equities and artificial intelligence, brings a wave of opportunities.
Charu Chanana,
Market Strategist
The AI fever has turned the technology into a darling, pushing crypto further into no-man’s-land. There are striking similarities between AI and crypto, and if these are to come full circle, AI won't be spared for bubbles.
Mads Eberhardt,
Cryptocurrency Analyst
Stocks related to artificial intelligence (AI) have appeared on investors' radars. Expectations are high, but it may be necessary to consider how to get exposure to AI in a diversified way.
Hans Oudshoorn,
Trainer Academy
The USD is on its back foot as markets celebrate an eventual Fed rate peak and steady long US yields. The stakes are even higher for the Japanese yen if longer major sovereign yield curves have to price in economic acceleration.
John J. Hardy,
Head of FX Strategy
While commodities, broadly speaking, have faced some tough months, a partial reversal during June could signal that the asset class is getting back on its feet with energy holding up and precious metals with upside potential.
Ole S. Hansen,
Head of Commodity Strategy
As inflation remains high central banks face hard decisions about whether they should keep hiking interest rates or stop. Meanwhile, the rise of AI creates bubble-like conditions that only make the decision harder.
Althea Spinozzi,
Senior Fixed Income Strategist
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