Where Now in Markets? Narrative Control, Cyclical Low Tide, and Pro-Competition.
My brother and I joke that when we get through a project, that a "lull" will come and we can rest.
It never does.
Worse, a lull isn't actually something positive, as it's directionless and risky.
Today the markets are in that pre-earnings month lull.
We were oversold in December coming into January earnings
The first earnings are larger companies who both see stronger demand (customers see them as less risky to buy from) and have more flexibility to move numbers around in their financial statements
The February earnings were from smaller companies, which were not as strong, on average, right when the market was less oversold, resulting in the markets rolling over
Now, we are in the post earnings season lull. Markets will trade randomly on whatever data catches traders' eyes.
Highest on the list are:
Inflation
Fed talks
Economic data.
Inflation is the biggest worry.
Yes, inflation is lower than last fall, but it is coming down at a slower rate than desired, meaning it is sticky at the 5% rate, where the Fed wants it to come down to 2%.
The Fed is next.
When risky markets like tech stocks and crypto rally so fast and furious as they did in the first 3 weeks of January, the Fed knows markets haven't capitulated. If the Fed were to "pivot" and stop raising rates, the risk would be that the market rallies strongly, people get overconfident, and buying resumes, thus pushing up inflation.
Then you get a period like the 1970s of inflation that won't go away because markets know the Fed will blink before causing real economic harm.
The Fed has studied this period, and they are determined to get rid of the Fed Put - the idea that the Fed won't let markets go down too far. They have to let them go down farther and damage the economy more than they'd like to just to get rid of the psychological component of expected inflation. They need us to give up, get worried about a deep recession, and stop purchasing things.
Economy is next.
Only a recession can embed disinflationary pressures and help the Fed reach their goal of 2% inflation.
Thus, by definition, we MUST overshoot to deflation and shrink the economy.
During this lull, look for Fed comments, inflationary data and economic data to move markets. Keep in mind the Fed wants downward pressure on inflation, and thus downward pressure on markets and economic data
Bear markets and regulatory clampdowns
Regulatory changes often mean investing opportunities. Investors find the new cracks, and flow through them like water through cracks in a sea wall. It's inevitable and unstoppable.
Rewind: 1996 US Telecom Act
Back in 1996, after becoming completely fed up with AT&T's monopolistic shenanigans (and total lack of willingness to build innovative products for consumers) the Telecommunications Act of 1996 became the first major overhaul of telecommunications law in 62 years. The goal of this new law was to let anyone enter any communications business -- to let any communications business compete in any market against any other.
In 1996, I was a newly minted tech analyst at Farmers Insurance. Everyone, including me, focused on the breakup of AT&T and which "Baby Bell" to invest in post-breakup. Lucent, AT&T's equipment arm, was part of the breakup and was a home run of a stock.
Meanwhile, the ocean of real innovation was flowing through the cracks.
Faster than rabbits breed in springtime, ISPs, internet service providers, were being formed and going public. Netscape came public. The REAL impact of the 1996 Telecom Act was NOT to break up AT&T.
The 1996 Telecom Act said anyone could compete in communications, birthing the real dawn of internet age.
The internet, previously arpanet, had been "around" since the 1960s. You read that right. This regulatory clampdown of breaking up AT&T gave the internet oxygen to compete as a communications platform. The rest is history.
Regulatory clampdowns happen in bear markets.
Increased restrictions are more politically palatable when people feel violated having lost money, and want someone to blame and to feel next time will be different.
No one likes a party pooper during a bull market.
AND, like the 1996 Telecom Act, restrictions on one party (AT&T) opened up the runway for another (internet businesses).
Where are the changing tides today?
Antitrust Tides in State of the Union
Matt Stoller writes BIG, about the politics of monopoly power. When I started reading his newsletter, he was permanently annoyed that governments worldwide were allowing large tech companies to build their monopoly power unchecked.
Fall 2021, (not coincidentally a few months after the all-time high in tech stocks), we started to see signs of governments becoming more emboldened to bring formerly untouchable tech companies to task and make meaningful changes. Stoller was cautious that these new efforts would effect any change.
Now, Stoller's tone is close to incredulous at how the pendulum has swung. You can argue the benefits of monopoly power, open free markets (and what those are, since governments argue you need governments to keep markets open and free), vs letting companies compete without intervention. Either way, the winds have shifted.
Some looked at the Trump era as free markets for all, but he could read the changing appetites of voters.
Trump brought the first antitrust action in 20 years, against Google. And then he brought another, against Facebook/Meta.
Within the FTC, the anti-monopoly voices are gaining so much ground that two of the 5 commissioners quit. They will be replaced by republicans, but the momentum has shifted.
We are in a new anti-monopoly era.
The Republicans know voters have had it with large companies ramping up prices, killing competitors, holding up employees with non-competes, and more.
This is NOT a political newsletter. I watch regulatory changes as they can drive some of the largest multi-year investment gains I have seen in my career.
What will we see?
Layer 1:
Facebook, Google, Microsoft and Amazon can't simply buy their smaller competitors before they become a threat.
VC investing environment and outlook for smaller internet, platform and software companies vastly improves.
The exit strategy of "Google or Facebook will buy us" won't hold water.
Layer 2:
With more VC money going into software and internet companies, we will have a very strong bull market for small cap software coming out of this bear market.
AI will likely disappoint vs all the dollars chasing it (the deal that OpenAI signed with MSFT in order to post an "up round" has MSFT grabbing the bulk of revenue from the venture)
Deep tech, software to upgrade our internet experience, and new ways to shop, search, and solve our problems.
Layer 3:
Just because regulatory pressure has increased, does NOT mean the end for Google, Facebook, Apple, etc.
These large tech companies got here for a reason. They still benefit from massive scale economies and network effects. Look for opportunities where they are oversold.
Look for mid-sized companies with huge network effects who can now have more oxygen and become one of the next Goliaths.
What do you think will come out of this new pro-competition era?