U.S. tech regulations? Who wins?

A small number of U.S. tech companies now make up 15 per cent of the S&P500 and 50 per cent of the NASDAQ-100, and are thus heavily influencing the direction of a myriad of Exchange Traded Funds that follow these indices.

But many of those same tech companies have recently shot themselves in the foot and raised the ire of regulators globally. So we ask, could a regulatory response following the U.S. Senate hearings crimp earnings – and hit the returns of investors?

Watching one day of Facebook CEO Mark Zuckerberg’s testimony was frustrating, if only because the necessary regulatory response was obvious early, and another four and half hours of testimony remained.

In any scenario where a single man apologises personally for failing for three years in his duty to notify millions of customers that their trust has been breached, the obvious issue that needs to be corrected, whether by the company or by the regulators, is that ‘one man’ remains responsible.

Mark Zuckerberg said:“I apologize for any harm done as a result of my neglect to consider how quickly the site would spread and its consequences thereafter.”

That statement however was not made during Zuckerberg’s recent Senate testimony. He offered that apology in a 2003 letter to the Harvard University student body after building the Facemash website for rating female students on appearance.

Recently, Wired Magazine’s Zeynep Tufekci laid to rest any residual belief in Zuckerberg’s claim that next time will be different, documenting Facebook and Zuckerberg’s “14-year apology tour”, and listing a conga-line of profit-motivated management fumbles.

Facebook has arguably constructed not only the most pervasive surveillance systems in the world, it has built one with hitherto unknown powers of persuasion – a propaganda machine WWII combatants dreamed of. Keep in mind there is enormous value being built here.

Regulator trust has however understandably plummeted, and it would be surprising, if not stunning, were Big Tech permitted to continue self-policing. Zuckerberg himself agreed some regulation was welcome.

Facebook’s listed company status and profit motive, and the elevation of its leader to demi-god status, has resulted in a failure that has compromised democracy and ‘delegitimized’ the outcome of the Brexit and Donald Trump elections – arguably two of the most important elections in recent history.

The big issue for investors, from all of this, is that many aren’t being selective in which technology companies they invest, and while Facebook’s library of billions of lives and their memories may indeed give it an impenetrable moat, there are investors who have blindfolded themselves, been less than discerning and simply bought a tech-heavy index ETF.

As the nine-year bull market has progressed, an overdependence by US index funds on a hyper-narrow band of technology stocks – many not earning a dollar of profit – has transpired, and never has so much capital been concentrated in a single sector that, through ETFs, can be sold at the click of a mouse.

But it is the weighting of tech stocks in the indices that investors in ETFs and Index Funds should be concerned about in light of a regulatory backlash.

A handful of Big Tech companies including Apple, Netflix, Google, Facebook, Microsoft and Nvidia now speak for 15 per cent of the S&P500 and 50 per cent of the NASDAQ-100. In a recent report, one of the most bearish analysts, Michael Hartnett, aligned Big Tech today with the tobacco industry in 1992 when the Supreme Court ruled it liable. That does sound like an attempt to grab some attention. Any regulatory change could take years. Indeed, consumer pricing remains the key measure in the framework for current Antitrust laws. This would need congressional and senate heavy-lifting of the herculean kind to be changed.

We currently believe it is safe to say that Google, Facebook, Microsoft and Apple, for example, are all here to stay. And we also believe it is safe to say that smartphones, Google Earth, and the internet are no longer merely modern conveniences for consumers. Having the data from those assets concentrated in the hands of a few powerful companies could represent a vulnerability, especially if the data looks to some a lot more like “national security assets”.

Nevertheless understanding Big Tech’s massive contribution to investor returns over the last few years and their weighting in the major indices, and appreciating the significant shift in the regulatory environment that appears to be afoot, investors who are blindly following tech-heavy index funds through ETFs need to be prepared for hitherto unanticipated consequences.

At Montgomery we believe the current fears have provided an opportunity to selectively invest in some names at discounts to our estimate of their value. Rather than buying index ETF’s blindfolded, The Montgomery Global Fund has carefully weighed the opportunities and elected to own Facebook, Google and Microsoft. By avoiding the overpriced tech companies with little in the way of earnings, The Montgomery Global Fund has taken an active approach to the risks and rewards now available in the technology space.

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