Leaders of the Biggest Stock Market Rally Ever Could Be Poised to Become Laggards
U.S. stocks keep rolling, mostly led by Big Tech and the passive inflows drifting into the top of the food chain. But what if those most responsible for the historical multi-year rally in stocks suddenly start to wither? Investors need to pay attention because a market correction is a likely result.
Specifically, I’m referring to a potential breakdown of market leadership regarding the FANG stocks. That is an acronym for the market’s biggest leading technology companies: Facebook Inc (NASDAQ:FB), Apple Inc. (NASDAQ:AAPL), Netflix, Inc. (NASDAQ:NFLX), and Google, now known as Alphabet Inc (NASDAQ:GOOGL).
As 2017 wore on, some troubling developments materialized with each of these bellwethers, prompting us to ask the question: What happens to the market if Big Tech leadership starts to fail? We haven’t had to ponder this question in almost a decade.
So far, each of these stocks has been bulletproof. Like everything else since 2012, investors have shrugged off negative news, opting for a “buy the dip” strategy that has remained surprisingly enduring. But for how long? As we will see, the severity of certain crises in Big Tech won’t be so easily dismissed heading into the new year.
The Many Challenges Facing Big Tech Leaders in 2018
The fact that FANG stocks are facing mounting challenges is not news. Massive international companies of this scale always have competitors nipping at their heels and corporate lawyers defending one lawsuit or another. It’s the severity of the problems the FANGs are experiencing, each threatening to throw a serious wrench in their business models or operational capacities.
With Facebook, the challenges are cumulative. In September 2017, Facebook was found to have allowed on its web site inauthentic Russian ads that tried to influence voters during the 2016 presidential campaign. Also in the same month, a Pivotal Research Group analyst said that Facebook’s “Ads Manager” claims a potential reach in the key U.S. demographic that is wildly exaggerated over actual U.S. census data. (Source: “Facebook inflates its ad reach by millions, analyst claims,” CNBC, September 6, 2017.)
Both instances did no favors to Facebook’s reputation and credibility with advertisers.
There are also serious issues looming on the regulatory front. Some influential nations like Germany are threatening to impose sanctions if “hate speech” isn’t removed fast enough. Others are peering into Facebook’s ad revenue model and wondering whether antitrust laws should apply. And of course, conservatives are quitting Facebook in droves, instead opting for competitors like upstart Gab, whose “speak freely” motto is a refreshing change from the increasingly autocratic ways of Facebook’s censor police.
With a full 98% of quarterly revenue coming from advertising and constraints to growth emanating from credibility and censorship factors described above, we wonder if Facebook’s stock is finally poised to stall. (Source: “Facebook nears ad-only business model as game revenue falls,” Reuters, May 4, 2017.)
With Apple, the challenge is much more specific. On December 20, Apple dropped a bombshell when it announced its proprietary “iOS” operating system throttles performance on some “iPhones” and “iPads” that have older batteries. In other words, Apple was purposefully degrading battery performance in new updates sent to those devices, thus shortening the shelf life of the product. (Source: “The real Apple iPhone battery scandal is that it took control away from customers,” Business Insider, December 20, 2017.)
Of course, Apple maintained that it was for the consumer’s own good, but few are buying it. Apple is staring down the barrel of at least eight lawsuits filed in U.S. District Courts in California, New York, and Illinois—including one for $999.0 billion. Given the circumstances surrounding the case, it’s not hard to imagine a large summary judgment being successful. And obviously, the potential fallout from consumer skepticism and disgust will be significant going forward, although to what degree remains to be seen.
In a similar vein, Netflix’s potential issues are focused and specific.
In a significant blow to the company, Walt Disney Co (NYSE:DIS) announced in August that it would be pulling content and starting its own streaming service. This puts a gaping hole in Netflix’s content channel targeting younger consumers, which form a significant portion of its viewing audience (as any parent with young kids will attest).
Furthermore, the pending AT&T Inc. (NYSE:T)/Time Warner Inc (NYSE:TWX) deal could deliver a stinging threat on two separate fronts. For one, the new entity would increase competition by way of delivering established content via brand name producers like HBO and CNN.
Secondly, AT&T owns the fiber pipes, which means it could theoretically provide preferential delivery of its own content. There’s nothing that ruins an online viewing experience more than latent connection speeds. Netflix would be at risk because it owns none of the infrastructure that keeps its business model running smoothly.
Finally, there’s Google. In a surprise move two weeks ago, the company announced Executive Chair and CEO Eric Schmidt would be resigning effectively immediately and transitioning to a “technical advisor” role. Schmidt first joined Google as CEO in 2001, back when the company only had several hundred employees, and became its executive chairman 10 years later. (Source: “Eric Schmidt is stepping down as the executive chairman of Alphabet,” CNBC, December 21, 2017.)
Of course, surprise moves at this level don’t happen spontaneously. Whether there is specific non-public reasoning is unclear. Regardless, Schmidt’s resignation could, at the very least, threaten Alphabet’s profit growth for a few quarters as the company’s new leader forges ahead with his or her new vision.
With all the serious challenges facing Big Tech, investors should be cautious. After all, it was Big Tech that led the market up in the first place. Should the FANG stocks stall or falter, the market will need new leadership candidates to keep equity prices marching higher. Given extremely frothy valuations and the current trajectory of the business cycle, it’s hard to envision where that leadership comes from.
Please note, this isn’t a specific call to action. The old axiom “the market can stay irrational longer than you can stay solvent” is more prescient than ever. But given the extreme challenges Big Tech is facing on multiple fronts this year, it may be a good time to take profits. We think it’s unwise to be overexposed to equities when the market leaders responsible for the greatest stock market ever start breaking down.