Big Tech Eats World

Big Tech Eats World

Big tech is awfully interesting. They keep on getting bigger and bigger, even when the fundamentals aren’t. At this point, Apple is bigger than the third largest stock market in the world, and bigger than the Russell 2000! Of course, it’s hard to say what happens with certainty, but what I think is going on is a combination of several things. I’d say big tech has benefitted from passive inflows over the last dozen years or so, as that helps the big get proportionally bigger.

Let’s pause for a minute, there. Did indexing start in 2009? No. The Dow Jones started in 1885, the S&P 500 has been around since 1957, and Vanguard started the first index fund in 1975. Why has index investing take so long to seem like the only obvious choice? Like all strategies, concentrating in the biggest stocks doesn’t work well all the time. When the market is heavily concentrated in one area, the index is subject to potential underperformance when that area underperforms. Most large indexes are currently slanted towards growth over value. When value outperforms, big indexes will underperform. Recessions are also often hard on the big indexes. We may have had a long, relatively calm period for a good while, helping passive investing, but looking ahead, it sure seems like there are danger signs.

Big tech has also been at the heart of the buyback machine that’s sprung up.  Low interest rate debt is used to buy shares, many of which have been given freely to employees. That’s a great tax dodge, and it looks like employee costs aren’t as high as they actually are. That’s, arguably, been going on for a long time, but the period of low interest rates made the technique pretty aggressive.

What caused the dramatic outperformance of big tech this year? There are several likely reasons, such as simple reversion from last year, a temporarily friendly liquidity environment, and better-than-feared earnings. I think we mostly have FOMO, though. Since about 2020, the idea of hiding in ‘safe tech names’ has had a lot of traction. Back in the sixties, you couldn’t get fired for buying IBM, now you can’t get fired for buying AAPL and MSFT. Many investors are underperforming this year, and they hope big tech keeps them in the game, plus it’s practically like buying the index anyway, since they’re such a large percentage of the index. Buying big tech has become safe and comfortable, and thus, popular.

This is a fragile market. What exactly causes selling? That’s hard to know. Some bad news from big tech? Just the weight of the structure? Sales and earnings aren’t very good, with rapid slowing since 2021. People are paying more for tech stocks now than they were at the market peak, relative to the rest of the market, and despite higher rates. At some point, you run out of suckers.  That doesn’t have to happen tomorrow, but it seems like a risk of note.

Cem Karsan of Kai Volatility Advisors thinks heading into and out of OpEx this Friday is a time when we could see a volatility shift. There’s a lot of short volatility heading into June, and as May volatility gets unpinned, that may start to pressure those positions. Does that necessarily mean big tech has to underperform? Of course not, but could it represent a potential opportunity for big tech to take a break? Could we get lasting volatility to cause some trouble?

In general, I’d expect the machine to go in reverse, at some point. You can dodge fair value for quite a while, but it’s hard to do it forever. It seems to me like the factors of tech outperformance listed above are likely to be over. The machine going in reverse means passive selling knocks big tech down, then active sellers get out because they’re hurting performance. Higher rates mean the buyback machine is getting a lot more expensive. Tighter credit means fewer companies have easy access to funding. Instead of leading upside, big tech could, and probably should, lead downside.

In broad terms, positioning in big tech is high but the secular reality is weak. That’s a potentially dangerous mix, which makes me pretty hesitant to embrace big tech, at least right now. You can’t know the future with any certainty, but the odds of buying the top in big tech right about now seem fairly high.