Peter Choi, Senior Research Analyst, Vontobel Quality Growth Boutique, discusses medium- to long-term prospects for major US technology companies, which have rallied strongly in recent weeks, and how different regulations in the US and Europe could affect their performance.
Shares of leading US technology companies have rebounded vigorously in recent weeks from their bruising falls in the first half as investors draw on hopes that the sector can weather a global recession. How long do you think this Big Tech rally will last? Will it be short-lived?
It’s challenging to predict the near-term path of the economy and interest rates, and macroeconomic fluctuations will have an effect on these businesses. Investors in these companies will presumably be optimistic about their long-term prospects, but will also balance this against the potential for near- term volatility from economic cyclicality. During this current sell-off we found valuations that increasingly compensated us for near-term volatility, and used the opportunity to increase our weightings in technology holdings.
What should Big Tech investors be preparing for or be cautious of in the next few months and years? Particularly when it comes to the impact of regulations such as the US antitrust bill or the new EU rules approved in July? How much importance should investors be giving to these developments? To what extent do you think these will challenge the business model of these companies?
Governments have started to give greater attention to issues around antitrust and regulation. We expect limited changes in the US, as more ambitious antitrust lawsuits from the FTC or DOJ would face the challenge of overcoming decades of court precedent around the scope of antitrust law. This would leave Congress with burden of making more substantial changes through new legislation, but this appears unlikely given differing priorities between Republicans and Democrats and an overall lack of votes. In contrast, the EU is ahead of the US and the recently passed DMA and DSA target specific business practices employed by “digital gatekeepers” such as default settings, app store payments, cross-use of data, and self-preferencing.
These rules are more novel, and investors should be mindful of potential impacts to both profitability and future growth. However, impacts will take some time to play out as actual enforcement actions are not expected to begin until late 2023 or early 2024, and the big tech companies may choose to test some of these new laws in court. In addition, we expect the core franchises to remain intact as it would be exceedingly difficult to give rise to a new mobile operating system or new search engine for example.
Some fund managers have argued that while the impact of the growth selloff on Big Tech is a short-term trend that depends on the global economic cycle, the bigger change is that real chinks are starting to show in Big Tech’s core business model, which hinges on globalisation and the network effect to create scale. What are your thoughts on this? Could the bad news for Big Tech be more long lasting than previously thought?
The major global technology do benefit from a more homogenous operating environment. If the regulatory regime becomes more fractured as countries evolve differently, that can add complexity to the business model. However, this alone is unlikely to fundamentally change the strength of the core business franchises. The mega caps are still poised to remain some of the world’s most profitable businesses along with enviable growth prospects, although investors may need some recalibration of their expectations. A more concerning development would be if governments became more overtly nationalistic and sought to actively develop their own local replacements, but that is not the current trajectory.