The Stock Market And The FAANGs

|
Includes: AAPL, AMZN, FB, GOOG, GOOGL, NFLX
by: John M. Mason

Summary

The "new" stock market is different from the past as transitions into the "new" Modern Corporation are accompanied by changes taking place in public offerings and declining public companies.

Also, new information points to the fact that only between 5 percent and 10 percent of all public companies are earning any profits, with the rest just "burning money."

Furthermore, the changes taking place in the structure of the stock markets also impact the ability of the ordinary investor to diversify their portfolios and they impact income inequality.

Last Friday, I wrote about “The Future of the Stock Market and the Future of the FAANGs.

The FAANGs are, of course, Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Alphabet's Google (NASDAQ:GOOG) (NASDAQ:GOOGL).

The reason for all the current attention is:

“The FAANGs account for about one-eighth of the S&P 500 Index's total value…."

Even more amazing, however, is that "they have provided half the market's growth this year."

Furthermore,

"Share price falls after disappointments from Netflix, Facebook and the smaller Twitter, have left the broader Fang+ index of technology companies down almost 10 percent from its June high, despite strong results from Apple."

But, it is true that, "tech's share of the wider index is now the highest since the dot-com boom."

However, in the dot-com boom, "Big Tech" was much smaller and was made up of many early stage companies..."

But, one cannot ignore the fact that the current stock market is so dependent upon just a small number of very large companies, in terms of market valuations. And, these very large companies represent the direction that the "new" Modern Corporation is going.

There is much more to this than just the increased size of “Big Tech.” And, this, I believe, tells a story that is very important for us to understand concerning the United States economy and the United States financial markets.

Jeff Sommer writes in the New York Times about the fact that “The American stock market has been shrinking. It’s been happening in slow motion—so slow you may not even have noticed. But by now the change is unmistakable: The market is half the size of its mid-1990s peak and 25 percent smaller than it was in 1976.”

To back this up, he cites the work of René Stulz who is the Everett D. Reese Chair of Banking and Monetary Economics and director of the Dice Center for Research in Financial Economics at The Ohio State University. Mr. Stulz has just produced a paper for the National Bureau of Economic Research titled “The Shrinking Universe of Public Firms: Facts, Causes, and Consequences.”

Mr. Sommer writes that in the mid-1990s, there were more than 8,000 publicly traded companies on stock exchanges in the United States. By 2016, there were only 3,627.

Furthermore, “Profits in the overall market are divided among fewer winners. And as capital-intensive companies have been supplanted by those with value largely in intellectual property, the marketplace is less transparent.”

The companies, today, are much larger.

“In 1975, 61.5 percent of publicly traded firms had assets worth less than $100 million, using inflation-adjusted 2015 dollars. But, by 2015, that proportion had dropped to only 22.6 percent.”

Mr. Stulz suggests that the general public cannot build diversified portfolios as they once could.

In addition, “Profits are increasingly concentrated in the cluster of giants that dominate the market.”

“In 2015, the top 200 companies by earnings accounted for all of the profits in the stock market….In aggregate, the remaining 3,281 publicly listed companies lost money.”

Finally, “increasingly, value resides in intellectual property—‘intangibles’ like software and data and biological design—rather than in the production of physical objects like cars.”

This is the world of the new “Modern Corporation” that I have been writing about. These are personified by the FAANGs. They are the corporations whose foundation are the ‘intangibles,’ but who live off of networks that allow companies to reach economic scales that, in the past were unthinkable. Furthermore, these companies feast off of financial engineering.

And, what is happening to the “smaller” company?

Well, in this environment, a lot of “smaller” companies get swallowed up by “larger” companies. Much of “research and development” happens in smaller companies, sometimes helped out by the larger companies, and then, when success is imminent, the “larger” companies swallow the “smaller” companies.

Otherwise, many companies will stay private longer than they used to being financed by private equity firms. Many of these private equity firms “have insider access to innovative start-ups that may never go directly to the public markets.”

Guess what? “Main Street investors are consigned to a less diverse universe than they may realize.”

What is this all pointing to? It is pointing to the changes that have taken place in the world, and to the continuing transitions that will take place over the next few years.

The new “Modern Corporation” is dominating the world, even more so that it appears on the surface. And, whereas we worried about concentrated financial power in the past, we have to worry about even more concentration in the future.

In the past, we saw how economies of scale and economies of scope could produce giants in industry and in conglomeration, but the possibilities present then are small relative to what can be achieved today.

Furthermore, financial engineering has also become a dominating factor. Almost sixty years of credit inflation produced by the federal government has increased the use and sophistication of what can be done manipulating financial assets and instruments. Financial engineering greases the wheels for all the ‘intangibles’ that dominate today’s corporate world.

And, we see that private equity firms have come to dominate the netherworld of insider access to innovative startups, leaving very little left over to the “ordinary” investor.

This is the “new” financial market for the “new” Modern Corpiration.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.