Superstar firm vogue heads for fire of overvaluation or ice of regulation: James Saft

(Reuters) - It may not happen soon but eventually the vogue for investing in “superstar firms” like Google, Facebook and Amazon will end in the fire of overvaluation or the ice of regulation.

A small number of these superstars, and not just in technology, have increasingly separated from the pack in the U.S., outpacing rivals in revenues, profitability and market share.

This fact has not escaped researchers, who tie it to a diminishing share of the pie for workers, or investors, who’ve merrily bid up the prices of the few companies on the right side of current arrangements. (economics.mit.edu/files/12979)

Thus far in 2017, the so-called FAANG stocks of Facebook, Amazon, Apple, Netflix and Google parent Alphabet have accounted for close to 30 percent of the S&P 500’s gains and now comprise more than a tenth of its market capitalization.

The going is surely good now, and investors continue to pile in, but the outstanding performance and market position of top firms is attracting, as it has before in history, political opposition in the form of a move to tighter anti-trust scrutiny. Congressional Democrats’ 2018 midterm elections policy slate includes a pledge to crack down on “corporate monopolies and the abuse of economic and political power.” Though the plan notably focuses on communications and pharmaceuticals companies rather than technology firms, should it find political traction with voters there is little doubt FAANG stocks will soon be under the microscope.

Top White House adviser Steve Bannon also argues that companies like Facebook and Google, as essential to modern life, should be regulated like utilities, according to a story in The Intercept based on sources. (here) And Donald Trump railed in June at Amazon CEO Jeff Bezos, who he said “has huge anti-trust problems,” though this view likely turned on the president’s ire at his coverage in the Bezos-owned Washington Post.

White House views these days are famously unreliable and changeable, but it is hard to escape the conclusion that the U.S. has more market concentration than it has had in a long time, that this is a profitable state for those grasping the long end of the stick, and that politics and the law may soon disrupt the disruptors.

TECHNOLOGY VS COMPETITION?

The MIT study from earlier this year found that the superstar firms tend to be concentrated in areas with greater patent intensity, indicating that technology, rather than restraint of competition, is an important driver of this trend. A Goldman Sachs report released last week concurred, citing a growing productivity advantage of leading firms to the rest.

“We single out the technology hypothesis as the likely candidate that best explains the rise in industry concentration, given the overlap in timing of the take-off of information and communication technologies in the mid-90s as well as the finding

that industries with rising concentrations are also the ones with faster productivity growth and patenting activities,” Goldman’s Daan Struyven wrote in a note to clients.

“Over a longer horizon, our analysis suggests that the continued momentum of superstar firms could imply that relatively high concentration levels and trend corporate profit margins may persist.”

That analysis rather assumes that outside forces which can trump technology, as it were, won’t be brought to bear on leading firms. If market concentration is happening, and is hurting wage growth, regulation seems likely.

Neither the phenomenon of superstar firms nor the market reaction to them is new, strictly speaking. A look back at the vertically integrated industrial companies of more than a century ago shows a lot which is similar to today. Technological innovation certainly powered firms like meat packer Swift and Standard Oil but so, courts eventually found, did monopoly abuse. The FAANG equivalents of the early 1900s also powered market returns but an analysis of the trustbusting activities under Presidents Teddy Roosevelt, Taft and Wilson found that anti-trust enforcement went hand-in-hand with market declines. (here) No less a source than Irving Fisher, the economist who famously opined in 1929 that stocks had “reached what looks like a permanently high plateau” argued, after the crash, that the 1920s boom was caused in substantial part by overly restrained anti-trust enforcement.

In other words, we’ve been down this road before once or twice and can pick out some of the salient features. Technology does tend to accrete and concentrate market power. Investors reward this with high valuations. The U.S. democratic process usually acts to limit this process, which in turn hits stock prices. If it doesn't, as in the 1920s, the results for investors can be even worse.

Bets on tech stocks and market concentrations are a bet against history either repeating or rhyming.

(The opinions expressed here are those of the author, a columnist for Reuters)