Over the past, let’s call it three or four years, I’ve repeatedly referenced the suggestion that America’s tech titans aren’t actually growth stocks, but rather cyclicals in disguise.
Note the careful wording. I said I’ve “referenced the suggestion,” as opposed to suggesting as much myself. If the FANG contingent and its successor, FAAMG, were merely cyclicals in disguise, it was a pretty convincing ruse. And it went on for a long, long time.
That conjures a pet peeve of mine: There’s a threshold beyond which it’s disingenuous for naysayers to suggest that something (anything) which has persisted, but which is no longer the case, wasn’t real in the first place. Bitcoin is the quintessential example. Even if Bitcoin does eventually converge to its intrinsic, underlying value, naysayers like myself won’t be vindicated. It went from nothing to $60,000. With apologies to my own ego, there’s no sense in which someone who spent a half-decade arguing that Bitcoin was worthless is “right” if it eventually ends up crashing to pennies two decades later. It’s too late to be right on the initial call. If I (or Jamie Dimon) want to make a new Bitcoin call, predicated on the same thesis or, if I want to be intellectually honest, an improved thesis that takes account of what went wrong with the original, that’s certainly fine. But that original call was wrong.
The same goes for the post-financial crisis bull market. Those who spent a decade insisting it was a house of cards weren’t vindicated by the pandemic crash, just like Jeremy Grantham wasn’t vindicated in his folksy bubble warnings from 2020 and early 2021 by the 2022 bear market. Again: There’s a threshold beyond which naysayers can’t be described as “right” on any common sense definition of the term. Sometimes that threshold is temporal (e.g., if something goes on for a decade, anyone who said it had no staying power in year two was, at the least, more wrong than right). Sometimes it’s a matter of assessing the scope of the thing (e.g., if a two-year surge in a benchmark stock index sums to 75%, anyone who called it a head fake at 25% was, at the least, more wrong than right).
It’s through that lens that we have to assess the notion of America’s mega-cap tech champions as “imposters” — ostensible growth stocks which were never growth stocks in the first place. To be sure, they don’t look so “growth-y” anymore. The simple figure (below) shows revenue growth for Alphabet, Amazon, Meta and Microsoft.
As most readers are acutely aware, last week, all four companies delivered underwhelming results. There were red flags aplenty. A severe currency headwind impeded Microsoft, which grew revenue at the slowest pace in five years. Amazon guided well below the Street for Q4 sales. Azure and AWS growth looked relatively unimpressive (still healthy, but not high enough to satisfy every analyst, and certainly not breathtaking). And the artist formerly known as Facebook reported a second straight quarter of negative top line growth, while unveiling another large operating loss in the segment responsible for Mark Zuckerberg’s metaverse ambitions.
You could suggest a sea change is afoot. Indeed, Bloomberg’s Cameron Crise did just that. “One of the arguments in favor of exorbitant tech-sector valuation is the tailwind of secular growth [but] it sure looks like that story is coming to an end,” he wrote, in an excellent column last week.
This is an even bigger story than it appears at first glance, which is saying something because suggesting that these stocks were “pretenders” all along (Crise didn’t say exactly that, but others have) is itself a pretty audacious claim. If this cohort can no longer be depended upon to play Atlas, it undermines the entire case for US equity market exceptionalism. Ironically, a key headwind for tech revenue growth is the strong dollar — one kind of US exceptionalism is undermining another.
“I found it fascinating that the post-earnings meltdown in [Meta] has taken its cumulative return since the IPO listing below that of the S&P 500,” Crise went on to write, adding that “if some of the biggest, most valuable companies in the US (and the world) no longer offer the (ahem) hope and dream of persistently high levels of growth into the distant future, that should probably result in a higher risk premium/lower secular valuation moving forward.”
He tossed out a number of eye-catching factoids. For example, if we take the midpoint of Amazon’s lackluster Q4 guidance, top line growth this quarter for the company would be the second-slowest ever, and full-year growth would be nearly five full percentage points below the prior low for annual growth (notched in 2001).
I’d be remiss not to note that SocGen’s Albert Edwards has, for years, argued that some high-growth US tech companies might one day be “exposed as cyclical imposters” in a repeat of the dot-com bust.
Edwards is fond of the figures (above) from Gerard Minack. They underscore the risk to US exceptionalism.
Of course, when it comes to valuations, a lot hangs on the evolution of US rates. These names could rapidly re-rate in the event bonds rally and mega-tech clears lowered bars next earnings season. But the discussion is well worth having. Last quarter’s tech results might’ve been a “milestone… that could have broader implications down the line,” as Crise put it.
I don’t have the answers. I think it’d be too much to suggest, after all these years, that America’s best and brightest tech juggernauts were never growth stocks. But if they’ve morphed into cyclicals over time (which is certainly possible given the cyclical nature of the ad business, Amazon’s consumer bellwether status and the somewhat unnerving prospect that even the cloud businesses aren’t recession proof), then the ebb and flow of the macro matters a lot more than we thought for the stocks that still comprise an outsized share of the US benchmark.
Finally, I’d pose a question to readers: How much of this is due to saturation? If you include Netflix in the discussion, that question is all the more pressing. I don’t have a Facebook account, let alone an Instagram page but, I’m told, a “few” other people do. Maybe it’s the case that ubiquity has become an operational headwind for Facebook, Netflix and (gasp) Apple.
Great food for thought.
“Finally, I’d pose a question to readers: How much of this is due to saturation?”
The fact that many of the tech titans have been turning their attention to the other titans’ markets (such as AMZN getting into targeted advertising) suggests the answer is yes.
Absolutely. Market has reached saturation. I’m not understanding what growth would look like at least in the domestic market. Everyone who wants a streaming account already has one.
And incidentally, targeted marketing doesn’t work very well and that has to be hurting add sales. Case in point, last month I insulated my attic. I did some googling about insulation products. Now a month after I’m done I get targeted ads trying to sell me insulation. You can’t sell me stuff based on where I’ve been, you have to sell based on where I’m going, and the add AI hasn’t figured that out.
Great post.
Another “saturation” headwind is globalization turning into nationalism and the nature that these firms are the first movers and easily copied at this point.
China has their own social networks and streaming platforms. Why not Europe too? At the end of the day there is data stored in a database or cloud storage, and these services simply gate access the information. AI has been democratized and open sourced — anyone can run a bunch of “posts” through a neural network with some user attributes and spit something back. There’s no innovation for owning the rights to a film and letting my television stream it.
The same goes for cloud services. Azure / GCP / AWS, with minimal differences all offer the same services. I expect the same from Chinese cloud outfits.
I wouldn’t say they were imposters all along, but the innovation happened over a decade ago. Now they just hire MBAs and expensive software engineers who think it’s impressive they work at big tech and don’t push the needle. I’m reminded of some quotes from Eric Schmidt about the software engineer who stole secrets from Google and went to Uber.
Eric knew the business needed these types of driven folks, despite their personalities. Not someone who went to MIT, got good grades, puts in 40 hours a week, and makes a change in three years when their stock options vest.
Crypto also?
The industry is becoming mature and the barriers to entry for cloud are not that great. Amazon’s profits are mostly if not entirely tied to AWS, which has little to do with their core business. Their market share in the cloud market is significant, but they are not likely to expand beyond western countries in any meaningful way and those markets are getting saturated from what we are seeing.
Thank you for this analysis. I’m shocked at how long these companies have been able to sustain their growth rates. I thought the law of large numbers would kick in much sooner than it did. At some point, very few things will move the needle to continue driving meaningful growth, but these companies kept figuring out how to sell more and more. Are we at the saturation point? I have no idea, but if nothing else, the cash flows should sustain enough stock buybacks to grow EPS.
Interestingly, I was looking at the cash flows for Apple and Meta today. Apple’s operating cashflows are maybe 2.5x of Meta, but Apple’s valuation is nearly 10x. Why? Meta is outspending Apple 2 to 1 in CapEx. It’s no wonder investors aren’t enamored with Meta at the moment. Despite that massive investment in CapEx, Meta can’t even grow their top line.
Your point raises an interesting question. If one is not paying for growth (or very low growth — concomitant with the growth of the economy) than what is one paying for when buying these stocks? Surely not dividends. Apple’s dividend is what, 0.6%? I guess we are paying for stock buybacks and an implicit promise of growth that may or may not come to fruition — as we are seeing.
All of this — clinging to the belief that growth has no boundaries — will happen again and again. This one was a whopper with a few crazy (probably literally) personalities to match.
Brc – now that’s one good question, ain’t it?
As companies mature, they become more cyclical. Just a corporate truth. Meta has very long-term problems, read as, so long as Zuck is boss and has his VR metaverse delusion. The three cloud kings will be fine once the dollar stops appreciating. Google will have baby googles. Amazon will disrupt more businesses and spin ipo AWS. Microsoft will be the winner in VR gaming and other interesting things.
Back about 12-15 years ago I opened a Facebook account, set all the security and privacy settings to the max, set a long random password, logged out. Never logged in again. Did it to stop potential imposters.
A few truths need to be stated in relation this discussion. #1, there is no such thing as the tech “industry.” The word “industry” is defined as a group of firms that all make products that are more or less perfect substitutes for one and other. Tech is actually an economic sector in which there are many actual industries, chips, software, machines to make chips, and so forth.
#2, no industry can grow faster than the economy as a whole indefinitely, otherwise it would become the entire economy. #3, no firm can grow faster than its industry indefinitely or it will become the industry. This has happened once or twice and we passed several laws to respond to just such an outcome. If it were to happen see #2.
#4, as H has often accurately pointed out, no single point forecast will ever be accurate in the economy, the markets, etc.
None of this is arguable. It’s all just the math involving statistical distributions and the nature of growth. Eventually, anyone betting the house against anything related to these truths will lose. We are just seeing the math. Eventually all growth rates fall without stopping.
Some years ago a colleague of Michael Porter, the Harvard economist who first wrote about the nature and sources of competitive advantage, did a study of the conditions of major US industries. First, and this is a tautology, half of them were growing slower than the economy. Second, and not so obviously, more than 500 of our mature industries were actually suffering inexorable revenue declines. The same outcome is happening now and will keep happening in the future. It’s the math.
So, the age-old transition of “shiny new technology” to “infrastructure” has come to social media and cloud computing?