The Lex Newsletter: Tech rout — it’s really Zuck’s

Dear reader,

Investors typically succeed thanks to luck, inside knowledge or rigorous logic. Luck can run out. Inside knowledge can land you in jail. Cognitive biases can derail logical deduction.

The latter problem is illustrated by the tech rout. It continued this week with a drop in the shares of Meta. The wider crash has this year removed more than a third from the value of the Faang stocks plus Microsoft. That equates to the destruction of $3.5tn in market worth, according to Refinitiv data.

If we continue like this, real money could soon be in peril.

Here is a chart using S&P CIQ data that summarises what has happened so far, apart from at Facebook owner Meta, which I will come to later:

Lex’s view prior to the rout was that tech stock valuations consisted of a real element and an illusory element. By automating everything from advertising to home shopping, tech companies have been seizing the revenues of many traditional industries, but with much higher profit margins. That represented a secular trend.

The illusory element was an asset bubble pumped up with free money. That is deflating as interest rates rise and quantitative easing ends. A cyclical trend is going into reverse.

The tricky bit is quantifying the scale of each element, then deducting the second from the first to produce a sensible valuation for the tech sector. The difficulty of doing so can be represented in graphic form by the famous Müller-Lyer optical illusion pictured at the top of this newsletter.

The line at the bottom appears longest to most of us. As you doubtless already know, both lines are actually the same length. The arrowheads are misleading cues (unless, research suggests, you are Zulu and have unimpaired dimensional cognition).

These misleading cues also litter investment, in the form of correlated but non-causal data, groupthink and the off-the-cuff opinions of financial columnists.

You may say to us: you’re Lex, you’re supposed to value things, so assign a non-illusory value to the tech sector.

We say: could we get back to you on that?

As it stands, a drop of one-third in the Nasdaq index is a pretty good start to eliminating the illusory element. Bombed-out bitcoin, previously a benchmark of speculative exuberance, has already delinked from the equity indices whose moves it once mirrored in exaggerated form.

We think interest rate expectations — to which growth stock prices are inversely correlated — have yet to catch up with the trajectory of inflation. So the correction still has further to go.

The typical mechanism for individual tech stocks to correct is for the company to say the sales outlook is weak or to publish disappointing revenue numbers. Teetering shares then fall disproportionately to this proximate cause. This week, Amazon was gloomy on its outlook while Alphabet and Microsoft had ho-hum figures.

An interesting tension is now emerging between the disruptive ambitions of tech tycoons and a market that wishes they would dial back investments and concentrate on making profits. This is most powerfully exemplified by Meta.

Mark Zuckerberg spooked investors with plans to blow as much as $39bn on capex in 2023. This as competitive threats to his platforms intensify and demand for digital advertising slows down.

The social network king now exemplifies the tech rout. Meta shares dropped about 25 per cent this week and are 70 per cent lower year to date:

There is increasing scepticism whether consumers will want the immersive version of the internet evangelised by Zuckerberg under the metaverse banner. The idea seems to be losing traction even within the ideological bubble of the US tech industry.

Elon Musk is, meanwhile, getting cold feet about turning Twitter into a no-holds-barred forum for “free speech”. He attempted to reassure nervous advertisers that he would not give trolls and conspiracy theorists complete free rein before completing the $44bn deal.

You can see why Musk previously tried to wriggle out of the transaction. The business would be worth only $13.3bn if its shares had lacked the price floor of the bid from the Tesla boss and fallen as much as Meta stock.

Heir brain

Jay Y Lee, the new executive chair of Samsung Electronics, will avoid controversy as assiduously as Musk pursues it. Lee has finally succeeded to the top role at the important South Korean chipmaker, which his family controls. A spell in jail for bribery and embezzlement had postponed that moment.

Lee faces a taxing diplomatic task as China, currently integral to the world chip supply chain, is forced to go it alone by the US. Asian chip companies such as Samsung and Taiwan Semiconductor Manufacturing Company are piggies in the middle.

Unlike his father Lee Kun-hee, the son is no business genius. But he can do what any pragmatic career manager would: hire a range of experts to support him and balance their advice carefully in his decision making.

Chipmakers are big customers for industrial gas. That’s one reason we are medium-term bullish on France’s Air Liquide. The secular trend for memory demand is on an upward trend even though it is set to suffer cyclical wobbles.

We also like the commercial underpinning of India’s Infosys. Some readers said we picked this topic to coattail on the news, a shocking accusation to ever make against Lex. To let me know what you think of this or any other aspect of our coverage, please email me at lexfeedback@ft.com.

It is true that the wife of the UK’s new prime minister Rishi Sunak has a stake in the company. But what really caught our eye was that the stock is three times higher than it was at the start of 2020. Big US tech has lost a lot of its pandemic-era gains. Infosys, which hires out IT consultants to businesses of all kinds, has fared far better.

The big cover-up

You would think from the above that tech was our only subject this week. But there was also plenty of European banking news. We were vindicated in our prediction that higher provisions would reduce reported profits at UK lenders such as Barclays and NatWest. Credit quality remains high, as numbers from Deutsche Bank and UniCredit also showed.

But if UK banks appear to be making too much money, Sunak’s government is more likely to increase windfall taxes. The provisions wheeze seems to be working, at least so far. UK media indignation focused on Shell’s profits this week.

Lex reckoned hydrocarbons groups should be investing more in renewables, even as Just Stop Oil campaigners were glueing themselves to the road outside the FT’s London headquarters.

It is incumbent on all columnists these days to sign off with recommendations for further reading. Shamefully, I rarely read business content outside work. My appetite for the subject is satiated by 12 hours per working day spent reading, writing, thinking and arguing about the subject. But I did enjoy a Markets Insight column, pertinent to the main subject of this newsletter, by Lex colleague Alan Livsey.

I have also been engrossed by Merlin Sheldrake’s book Entangled Life on fungi and related life forms. Sheldrake overclaims both for the health benefits of psychedelics and the similarity between mycelial networks and the neural kind. But he is correct in asserting the long-overlooked properties of fungi as symbiotic organisms.

Enjoy your weekend, whoever you are symbiotic with,

Jonathan Guthrie
Head of Lex