Economic dispatches, November, 2018
The stock market is tanking like an Abrams falling off a cliff. This in spite of corporate tax cuts and strong economic growth. A 25+% crash in oil prices is signifying upcoming economic weakness, but is also partly due to abundant oil supplies.
So, what happened? Two important economic principles are in play, momentum investing and market saturation. The FANG stocks act as an example here, as major players in the stock market, the economy, and our lives. These are Facebook, Apple, Amazon, Netflix, and Google. Unlike past stock market crashes, we can’t look into these companies and find fundamental weaknesses in their business models or execution. Nor are there emerging competitors to their business models. No, the problem is with their customers. The company valuations are dependent on the assumption of ever increasing consumer attention, leading to more usable consumer data (FB, GOOG), increasing entertainment consumption, or an increase in personal electronics purchases. This can be achieved by having more customers or more attention/demand per customer.
So much is already known. Lesser known is that the business cases for the company overlaps. One can text on an Iphone while watching a Netflix movie, or one can watch movies on Amazon Prime discovered by the Google search engine. But at some point market saturation based on human mental saturation is reached. The bullish case for these companies separates from the bearish case on the question of how much content consumers want or need, or how they interact with the contact. After a prolonged rise, there are hints that the bearish case is stronger, so the technology market, led by FANG, has corrected, dropping more than 10%. Unlike earlier market routs in 1999 and 2008, I believe these companies have strong fundamentals and will adapt. They are not going away, just receding a bit to give humans breathing room.
In game theory, we learn that stock prices are not only dependent on fundamental value. Momentum investing is relevant, making bull markets for stocks last longer, and making bear markets more painful. The reason is that stock purchasers, brokers and analysts don’t just look at the markets and the stocks, like I just did, they look at each other. Until others are about to sell it doesn’t make sense to sell, as that is “leaving money on the table.” But, wait too long, and the money goes away.
This implies that the FANG stocks rose too high in late 2018, and they corrected too hard. This is not a prescription for trading stocks, but what these major stocks are doing together with commodity prices like oil does provide a window into consumer sentiment and preferences.
