David P. GOLDMAN
This is how it always happens. Late Tuesday an obscure short-seller, Citron Research, announced that Twitter was the social media platform most vulnerable to privacy regulation – and its stock plunged 12% in the course of the day. All the other tech names followed, including the whole of the FANG+ Index (Facebook, Amazon, Netflix, and Google, along with a half-dozen other big names, including Alibaba). FANG+ lost 6% on the day, and MSCI’s non-Japan Asia stock index fell 1.4% overnight.
There wasn’t any news. Citron isn’t much of a market mover. Far bigger voices had offered direr forecasts in recent days, including Citibank’s equity research team with a missive headlined ‘Down the Rabbit Hole’ that warned of a 20% correction in the S&P 500. Stocks had recovered on Monday after the Trump team took to screens to assure the world that they sought a negotiated deal with China rather than a trade war. But in the end, what mattered was not Trump’s tariff shock but the simple realization that tech monopolies don’t last forever, and when they fade, they fade fast.
As I argued in this space on March 20, hundreds of billions of dollars of market capitalization hung on the illusion that driverless cars would add trillions of dollars of value within the discountable earnings horizon. The autonomous vehicle was the poster-boy for the supposed Artificial Intelligence revolution that would resemble a Second Coming of the Semiconductor. Uber’s killer car put paid to that; the real experts, as I reported, know that autonomous vehicles work only when the whole infrastructure around them is designed for them (as in China’s new cities).
Then we had the Facebook privacy scandal. Mark Zuckerberg turned out to be an unconvincing Man Behind the Curtain, reassuring users that the Wizard of FANG wasn’t stalking them. The real scandal, though, is the extent to which social media really adds value. When I click on an add for hyperphlombic sploonge, I know that Facebook will send me a dozen more ads for hyperphlombic sploonges, and that banner ads for sploonges will present themselves above whatever newspaper headline I attempt to read.
The trouble is that American wages barely keep up with inflation, and the wage growth of part-time workers (according to the Atlanta Federal Reserve) was lower than the growth of the Consumer Price Index during the past year. The American savings rate, meanwhile, hovers near its all-time low. Beam all the targeted advertising you want to Facebook users and they still won’t buy if they don’t have the money.
Wages are stagnant because productivity is stagnant, and productivity is stagnant because American companies invest in apps rather than plant and equipment. Asia is the main reason for America’s shift away from capital-intensive investments to “capital light” investments such as software. The large Asian economies, China especially, subsidize capital-intensive investments. They view a chip fabrication plant or an auto assembly plant as a public good, and reduce the cost of capital for private companies, just as the US subsidizes sports stadiums and airports.
The result is clear from a simple comparison of return on equity and capital intensity (the ratio of assets to earnings before taxes and interest) in the US and China. In China, the more capital intensive the industry, the higher the return on equity; in the US, the relationship is fuzzy, but there is a slight tendency for more capital-intensive industries to show lower return on equity.
Manufacturing has left America because it is cheaper to manufacture in Asia, because Asian governments make capital cheaper. That’s why labor productivity growth in the US hovers around the zero line.
Digital technology is changing the way Americans work, to be sure, but not necessarily for the better. The gap between the wage growth of full-time and part-time workers is widening, according to the Atlanta Federal Reserve Bank’s wage growth gauge.
S&P 500 employment stopped growing in 2015, although total employment continued to grow.
Large companies have found that they can outsource a large number of bureaucratic tasks to part-timers who are willing to work for lower compensation in return for flexible hours, just like Uber drivers. The hottest item among tech start-ups today is labor-sharing services for corporate businesses. That’s great for the millions of well-educated women (for example) who do not want to work full-time because of family responsibilities, but it does not increase productivity or wage growth.
In short, the American tech sector does a great job of exchanging photos and recipes and family photos, but it doesn’t do much for overall productivity.
Broadband, smartphones, e-commerce and e-finance play a very different role in emerging Asia.
An important facet of China’s Belt and Road foreign investment program targets broadband networks, smartphone sales, e-commerce and e-finance as a means of transforming the economies in which it invests. Two years ago I arranged a visit to the Shenzhen headquarters of Huawei, China’s premier telecommunications equipment producer, for the ambassador of a Latin American nation. After a three-hour tour through Huawei’s ample exhibition facility, the ambassador and her staff were seated in a small circular theater to hear the exhortations of a Huawei spokesperson. The Chinese told the Latin Americans that if they invited Huawei into their country to build a national broadband network and sell them equipment and bring Chinese e-commerce and e-finance companies into the mix, they too would have the sort of growth that China has enjoyed for the past several decades. More than 100 countries are now considering national broadband networks, with varying prospects, according to Huawei.
The United States is drifting towards the export profile of Brazil, with strength in agriculture commodities and energy but overall weakness in high-technology manufacturing and exports
The good news is that the prospects are good for a quantum-jump in productivity in the developing world. The bad news is that China is acting aggressively to position itself as the dominant equipment supplier, investor, joint-venture partner and technology provider in this revolution. By contrast, the United States is drifting towards the export profile of Brazil, with strength in agriculture commodities and energy but overall weakness in high-technology manufacturing and exports.
When Citron slimed Twitter, it reminded investors that today’s tech companies are monopolies, and monopolies don’t last forever. As I wrote in this space nearly a year ago:
“Tech companies now sit atop a virtual toll booth and impose a charge on a myriad of transactions. Like water and power companies, they have monopolies, although these monopolies are driven by the price of infrastructure and the network effect. Google has the Internet-advertising monopoly. Microsoft has the personal computer software monopoly. Amazon has the Internet sales monopoly. Facebook has the targeted advertising monopoly. And Apple has the oddest monopoly of all: it is the vehicle by which customers assert their individuality by overpaying the largest-capitalization company in the world.”
Both the Democratic Party and the nationalist wing of the Republican Party think that the likes of Google and Facebook should be regulated like public utilities, which would mean a sharp drop in profits. So apparently does the European Commission.
That portends the end of the second great tech bubble. But to which sectors should investors rotate? Energy is a bet on oil prices, and the US oil companies are a pricey bet. Financials have underperformed and are likely to continue to underperform. During the first quarter the total assets of US banks actually shrank, something that usually happens in recessions, and business loan volume is flat; if they can’t grow assets, they can’t make money, especially not with a flat yield curve and historically low net interest margins. What S&P calls the “consumer discretionary sector” is 20% Amazon and 7% Home Depot, two well-performing but pricey names. “Consumer staples” have done terribly as customers shift away from high-priced brands to generic substitutes. Technology ballooned to a quarter of the S&P 500’s market capitalization at the end of January, and there aren’t enough locations in the rest of the market to absorb that much market cap. That makes the US stock market dodgy for the rest of 2018.