The drumbeat of large-cap tech
BRIAN JACOBS, CFA 04-Aug-2019
Is it time to start paying attention to the drumbeat? That’s a question that tech investors may wish to begin pondering. Why? On July 23, the U.S. Department of Justice (DOJ) formally announced that it is opening an antitrust review of large-cap tech. Specifically, it is looking closely at “whether and how market-leading online platforms have achieved market power and are engaging in practices that have reduced competition, stifled innovation, or otherwise harmed consumers.” Although the DOJ did not name names, it doesn’t take a genius to figure out what online platforms dominate internet search, social media, and retail services.
For those investors who have been watching closely, this should not be a surprise. Previously, Assistant Attorney General Makan Delrahim delivered a blunt speech at a conference in Israel on June 11 titled “Antitrust Enforcement and Digital Gatekeepers” in which he used Standard Oil as an example that price effects were not the sole measure of harm to competition. Delrahim explained that often “calls for antitrust reform, or more radical change, are premised on the incorrect notion that antitrust policy is only concerned with keeping prices low. It is well-settled, however, that competition has price and non-price dimensions." On top of that, no one needs reminding that the U.S. is entering election season, and members of both major political parties have been critical of large-cap tech and their handling of consumer data, among other things.
All this suggests that the DOJ is getting serious about targeting technology despite a lack of higher prices in the products and services within these markets. Citing Standard Oil as an example should worry tech investors, given that Standard Oil was eventually found guilty of anti-competitive actions and was broken up into smaller independent companies.
We are not suggesting that any specific big tech names are headed for imminent breakup. In fact, it would be wrong to ignore the market power and resultant economic models of these large companies. They are simply too attractive to ignore altogether, and for that reason we would continue to advocate for some allocation to them—within reason. However, sentiment still matters, and so do potential new regulations. Rather than panic, investors should simply consider what the future environment looks like for the tech behemoths going forward. There is a very real possibility that the tailwind that they have enjoyed from their scale and dominance may begin to wane.
So what’s the actionable takeaway? Now may be a good time to revisit diversification within your tech sector and large-cap allocations to better understand how much sway the largest tech companies have in various portfolios or indexes. For starters, consider that the average company in the S&P North American Technology Sector Index has a market cap of $450 billion, while the average company in the Russell 1000 Growth Index has a market cap of more than $300 billion. In addition, any investment shadowing the Technology Select Sector Index would have a whopping 50% of assets in its top five positions alone. That doesn’t seem like a very diversified approach.
It’s sometimes easy to overlook that small growth stocks also have performed relatively well over the years despite the challenging (unfair?) competition from largest players in internet, video game, advertising or consumer applications. And now that the dominant tech companies are facing a stout opponent in the form of the DOJ, smaller growth companies may find themselves in an enviable position.
Given the recent formal announcement of an antitrust review, now may be an opportune time to consider strategies that tilt toward innovative small growth companies, many of which may have stock prices trading at a discount to their large-cap counterparts. At a minimum, investors may wish to consider allocating to investments that have more reasonable (i.e. smaller) positions in big tech.