2018 – The year of regulation for US Tech-Industry?

Facebook and Amazon dragged into controversies, Tesla’s cash flow in trouble. Nasdaq’s tech-heavy composite index is falling down month-on-month since January this year.

In such a volatile market situation – can we weigh the best case and worse case scenarios? And what can investors do to prevent the impact of this volatility?

Read this blog as Binod Shankar discusses the turbulent US equities market in detail.

What happened – The Background

• Facebook Inc. was hit with a data-privacy scandal.
• Amazon.com Inc. came under attack again by President Trump over its sales taxes and U.S. Postal Service contract. Amazon is also accused of being a monopoly.
• Concern mounted about Tesla Inc.'s cash needs.
• The broader, tech-heavy Nasdaq composite index, which soared 28% last year and gained an additional 5.4% in the first two months of this year, fell 2.9% in March, its worst monthly showing since January 2016.

The Question

• The big question is whether investors used the bad news simply to take some of their big profits. Or whether the developments point to trends that could curb the companies' longer-term business prospects, thus making current stock prices overvalued.
• Even after the tech sector's dreary week, Amazon's stock is still up 66% over the last 12 months, compared with a 12% gain in the benchmark Standard & Poor's 500 index. Netflix has doubled in price and Twitter has surged 93% in the period. The broad U.S. stock market is down about 10% from its January high. And that puts it some far ways off from a bear market (a drop of 20% or more)

Best case

• Amazon is a large employer and a well-respected brand. Plus, it has reduced prices for millions of customers and delivers great service. Also, it has an unassailable position in e-commerce. It’s difficult to justify regulating such a company. The U.S. Department of Justice focuses on the impact on consumers, not the impact on competitors when it evaluates antitrust issues. Given Amazon has been a positive force for competition and for consumers, it seems like it would be an unusual target. The Postal Regulatory Commission has consistently found that Amazon’s contracts with USPS are profitable. Additionally, Amazon gets a discount because of the huge volumes. It allows USPS to utilize spare capacity. Amazon, by paying USD 20 billion every year keeps USPS afloat!
• Facebook may emerge from this crisis with minimal regulatory changes and limited financial damage to its user base and advertising kingdom," even if this represents "the darkest chapter for Facebook and [CEO Mark] Zuckerberg in its 14-year history. Plus, for online advertising, there are only two places globally- Google and Facebook! Digital ad spending is expected to hit USD 375 billion in 2021 (from USD 266 billion in 2018). The median fair value is USD 185 which is a 16% upside from the last closing price.
• If you look at Trump, one of the things he ran on was de-regulation. So, he may not regulate the whole industry
• Technology stocks make up 25 percent of the S&P 500. Apple, Amazon and Google parent Alphabet alone have a combined market capitalization of around $2 trillion. That represents almost 10 percent of the index's total market cap of about $23 trillion. Tech’s heavy presence should act as its own insurance.
• A tariff tit for tat is a lose-lose scenario. So, it’s likely that after a bit of rattling, US and China will negotiate. This is Trump’s signature style- kick off with something dramatic and then scale down via negotiations!
• The secular trend in Tech – Big Data, Cloud Computing, Robotics, Artificial Intelligence- will only grow.
• The macroeconomic environment is strong- low unemployment, growing economy, inflation under control etc.

Worst case

• FAANG may become BAADD (big, anti-competitive, addictive and destructive to democracy).
• 2018 could be the year of Regulation.
• Any company making money from internet advertising (Fb, Google) may be regulated.
• Facebook escaped regulation so far by calling itself a Content Aggregation Platform but the Govt may call it a Media company. Subscribers may start leaving Facebook, quickly followed by advertisers. Watch out for declining subscriber numbers and any major advertiser departing Facebook.
• Amazon may get hit by anti-trust regulation. Also, online buyers may have to pay state sales taxes, making Amazon an unattractive marketplace.
• Expect more spending and more self-regulation/controls by tech companies to fix the issues. This may increase expenses and slash revenues.
• Also, Old Tech is less susceptible to regulation than New Tech. So Facebook, Google, and Amazon may get hit more by regulation than Apple, Microsoft, and Netflix.
• Heftier fines in future for fake news, data loss, data abuse etc.
• But Old Tech has other issues- tariffs. China may hit back on imports from the US of Apple phones and Microsoft software!

What should investors do?

• Since hitting their troughs in 2009, both the 9 had quadrupled in value as of January 2018. Since hitting their pre-Great Recession highs in October 2007, the Dow and S&P 500 rose by a respective 88% and 84% when they hit their all-time highs in January 2018. Thus, even with both indexes having dropped by 10% since hitting record highs, long-term investors should still be up considerably from where they were a decade ago.
• The S&P 500 experienced many drops from 1980 through the end of 2015. These market drops were remarkably regular occurrences over 36 years. The market ended up achieving a positive return in 27 of those 36 years. That’s 75% of the time. This happened just recently when the S&P 500 sank 11% in January 2016. It then made a sharp U-turn and headed for new highs.
• The mistake investors often run into is in focusing too much on nominal point moves and freaking out anytime the Dow Jones drops by more than, say, 300 points. However, a 300-point move in the Dow in either direction is nothing more than a 1.2% or 1.3% move.
• So, stay calm!