Regulatory Risk Looms Large Over Wall Street’s One-way FANG Trade

Before the renewed stock market correction that commenced on Wall Street on Tuesday, FANG stocks were back trading at a record high on Monday (see following chart). FANG of course stands for Facebook, Amazon, Netflix and Google. At this record high these stocks had a combined market capitalization of US$2.2 trillion or 9% of the S&P 500 (see following chart).

US FANG STOCKS AND S&P 500

Note: FANG = Facebook, Amazon, Netflix and Google (Alphabet). Source: CLSA, Bloomberg

FANG STOCKS MARKET CAP as a % of S&P 500 MARKET CAP

Source: Bloomberg

FANG stocks have risen by 63% since the beginning of 2017, compared with a 20% gain in the S&P 500.

What are the risks of continuing to own these stocks after the huge gains of recent years? The FANG stocks, for example, have risen by 63% since the beginning of 2017, compared with a 20% gain in the S&P 500. One obvious risk is an accelerating monetary tightening scare on rising inflation concerns in America, given that highly rated growth stocks are most vulnerable to higher interest rates. But to this writer a probably greater fundamental risk is regulatory, most particularly in the cases of Facebook and Google.

This risk is being driven by the increasingly evident backlash against social media as people finally wake up to what should have been obvious years ago. That is the sinister aspects of search engine and social media monopolies. But if such a backlash is building, with a recent cover of The Economist magazine titled ‘The new titans: And how to tame them’, the issue is whether this backlash turns into regulatory action creating meaningful downside risk for the relevant companies’ share prices. This is certainly a risk.

The best critique of social media seen by this writer is a book published last year titled, Move Fast and Break Things, by Jonathan Taplin. This book, written by a former 1960s music producer turned academic, highlights the monopolistic aspects of Google and Facebook, as well as the way they are engaged in a process that is destroying critical cultural infrastructure such as news and art, as well as fanning partisan politics by encouraging extremes only to communicate with each other in the by now well understood “echo chamber effect”. One of the more interesting revelations, among many, was the disclosure that Google staffers had at least 427 meetings at the White House during the Obama presidency, or an average of more than once a week.

 

Fake News and Fake Clicks

Then, of course, there is the ongoing brouhaha about so-called fake news, given the growing evidence of clever Russian exploitation of social media during the American presidential election. This has led to a series of articles questioning, in particular, the role of Facebook. Thus famous British historian turned polemicist Niall Ferguson, posed a pertinent question in Britain’s Sunday Times last October. “Is Facebook a platform for all ideas? Or the most powerful publisher yet?”

This is certainly a question worth asking in a world where a terrifyingly large number of people, particularly younger people, seem to gather their news from Facebook. This is why it is increasingly hard to deny the longstanding reality that Facebook in recent years has primarily been a media company posing as a technology company rather than the other way round.

Then there is the issue of whether Google’s and Facebook’s estimated 60% share of digital advertising revenue is really merited given the seemingly questionable nature of many of the ‘clicks’. Interestingly, Procter & Gamble (P&G) cut more than US$100 million in “ineffective” digital advertising in the second quarter of last year and found little impact on its domestic sales.

 

Social Networks: The Exchange of Personal Data for Instant Gratification

If this is the growing noise, many will protest that such concerns aired by aging counterculture relics such as author Taplin, a former manager for Bob Dylan’s backup group The Band, reflect generational chasms, and that millennials will continue to see nothing wrong in handing over all their data in return for instant gratification. Maybe. But it was interesting to this writer to see a Hollywood movie The Circle released last April. While certainly not a great film, the film did succeed in highlighting the creepy nature of social media as all privacy is sacrificed to the principle of being ‘connected’. And most of the actors were millennials. What is certainly the case is that the original libertarian ethos of the internet has long since degenerated into abetting and enabling a surveillance state.

GLOBAL DIGITAL INFORMATION CREATED AND SHARED 2005-2015

Source: KPCB

But beyond such ‘soft’ cultural issues of privacy, there are also practical commercial ones raised by the intensifying scrutiny. The most important is antitrust and whether these monopolies, given their dominant market share as a result of the ‘network effect’, should be broken up and, worse case for the share prices, turned into regulated utilities. In this respect, historians will know that the US has a long and proud tradition of ‘antitrust’.

Meanwhile, another dimension of the anti-competitive aspect of these business models is the way Google and Facebook seek, usually successfully, to buy any startup that could disrupt their domain. The obvious example is WhatsApp. On this point it is worth recalling that, during the approval process of that merger, Facebook pledged to the European regulators in 2014 that it would not share WhatsApp users’ data with the Facebook platform but started doing so in 2016. As a result, the European Commission fined Facebook €110 million last May.

 

Alibaba and Tencent: Social Control Trumps Monopoly Risk

It is probably safer to own the shares of China’s internet giants than the American ones.

Still the issue is, obviously, not what the Europeans do, but what action if any comes out of the US. In the meantime, a regulatory drive on the antitrust angle is much more likely in the US than China.

Whereas the degree of control in the marketplace is by its very nature controversial in the West, the degree of market dominance exercised by China’s internet giants, Alibaba and Tencent, is an enabler of increased social control from the standpoint of China’s central government, and therefore has real utility value in political terms. This is why it is probably safer to own the shares of China’s internet giants than the American ones.

Alibaba and Tencent share prices

Source: Datastream