After I interviewed Mark Yusko for the podcast I immediately downloaded a copy of Tao Jones Averages, a book he recommended during our conversation. The Author, Bennett W. Goodspeed, runs (or perhaps “ran” is more accurate as the book was published in 1983) a company called Inferential Focus and in the book he explains one of the company’s primary methods:
IF’s discipline centers on the reading of 180 publications, which range from Adhesive Age to Yankee (many of these subscriptions are trade periodicals). Such reading serves as a “radar screen” on which the anomalies, or clues of change, first appear. This reading also provides a feeling for what is normal, as one needs to know normality in order to recognize an anomaly (something that shouldn’t be happening in terms of “conventional wisdom”). When sufficient anomalies or breaks in a trend are noted, IF infers that a new trend is forming.
I don’t read 180 publications but the technology I use sources the stories I read from at least that many. And I do so for very similar reasons. I want to understand what the consensus is regarding the markets and individual stocks and how that might be changing. I’m also interested in insightful non-consensus views, as well, but even then it’s partly to help establish what the consensus is and how it might be wrong and in the process of changing.
There has been no clearer consensus in the markets than that which has elevated the FANG (or FAAMG or whatever iteration you prefer) stocks to such a lofty plateau. It doesn’t take reading 180 publications or even 18 to make this inference. Investors have become completely enamored with these to the point that the rest of the several thousand stocks in the market hardly merit a mention anymore, let alone any digital real estate on the screens of traders from Robinhood to Ameritrade.
They have been called, “infallible, unstoppable, inevitable, indomitable,” and countless other breathless superlatives. Investors and pundits have had heated debates over which will become the first trillion-dollar stock. They make up the core of almost every equity investor’s portfolio and have been responsible for all of the revenue growth and a large chunk of the price growth in the indexes over the past couple of years. Howard Marks recently summed up the general view towards the group:
Bull markets are often marked by the anointment of a single group of stocks as “the greatest,” and the attractive legend surrounding this group is among the factors that support the bull move… In the current iteration, these attributes are being applied to a small group of tech-based companies, which are typified by “the FAANGs”: Facebook, Amazon, Apple, Netflix and Google (now renamed Alphabet). They all sport great business models and unchallenged leadership in their markets. Most importantly, they’re viewed as having captured the future and thus as sure to be winners in the years to come.
Perhaps all you need to know to understand investors’ enthusiasm for this group is their valuations. The average p/e of the FANG four (Facebook, Amazon, Netflix and Alphabet, aka Google) is a lofty 114. Add in Apple and Microsoft and it comes all the way down to 83. At their peak in 1972, the “Nifty Fifty” traded at a relatively reasonable average of 42 times earnings. Marks draws an interesting parallel here:
The super-stocks that lead a bull market inevitably become priced for perfection. And in many cases the companies’ perfection turns out eventually to be either illusory or ephemeral. Some of the “can’t lose” companies of the Nifty-Fifty were ultimately crippled by massive changes in their markets, including Kodak, Polaroid, Xerox, Sears and Simplicity Pattern (do you see many people sewing their own clothes these days?). Not only did the perfection that investors had paid for evaporate, but even the successful companies’ stock prices reverted to more-normal valuation multiples, resulting in sub-par equity returns. The powerful multiple expansion that makes a small number of stocks the leaders in a bull market is often reversed in the correction that follows, saddling them with the biggest losses. But when the mood is positive and things are going well, the likelihood of such a development is easily overlooked.
And it seem to me, through the course of my reading and research, there is a not-so-subtle shift underway in the perceptions toward these companies. We could be in the midst of investors discovering that, as Marks writes, the FANG’s ‘perfection is turning out to be illusory.’
Over the past decade Facebook and Google have come to dominate the market of online advertising. If you want a presence online you have to go through one of the two that make up this duopoly. And advertisers, for a long time, were happy to participate but that could be changing.
Proctor & Gamble is one of the largest and most successful advertisers and brand stewards in history. During it’s latest quarterly conference call the company revealed that it cut its digital ad spending by $100 million. What effect did it have on its business? According to the company, it had none whatsoever.
CFO John Moeller explained, “What it reflected was a choice to cut spending from a digital standpoint where it was ineffective, where either we were serving bots as opposed to human beings or where the placement of ads was not facilitating the equity of our brands.” That word “ineffective” is pretty powerful but what is probably most important to P&G is the other part of what he said – that “not facilitating the equity of our brands” part. That’s really what they care most about. More on that in a bit.
Unilever has been even more aggressive in reducing its use of “ineffective” digital advertising provided by the likes of Google and Facebook. Business Insider reports, “According to estimates from MediaRadar, a New York-based advertising intelligence company, P&G’s ad spend dropped 41% year-over-year, while Unilever’s dropped 59%.” The fact that they can reduce their digital ad spending this much and feel zero business impact is a testament to just how ineffective it really is.
These mega-merchants of branded consumer products have always spent a ton on advertising. They are the best in the business at it. They are always on the cutting edge of the technology that matters most to building their brand awareness and loyalty. So when these two companies make a major change, the rest of the advertising world takes notice. But what is most important to note here is not just that they’re doing it but why.
The executives at P&G and Unilever know how to sell. Way back in the 1920’s car companies discovered how to do it. Charles F. Kettering of General Motors said, “Our chief job in research is to keep the customer reasonably dissatisfied with what he has.” It was a new technology (consumer psychology) used to sell more stuff and other companies in all sorts of industries caught on. From Rainbow’s End: The Crash of 1929:
Psychology was a useful tool because, among other things, it revealed a crucial paradox of consumerism: people bought goods to gain satisfaction, but the more they bought the more dissatisfied they became. To turn goods rapidly and in great quantity, the consumer economy had to be rooted in dissatisfaction: however much one had, it was never enough.
This form of consumer psychology is most valuable for selling durable goods. How are you going to get somebody to upgrade their car or their clothes or their radio (or their television or their smartphone) every so often? You make them dissatisfied with the ones they currently own. And boy are digital advertising platforms good at this. The Wall Street Journal reported recently:
If you’re one of the almost two billion active users of Facebook , the site’s blend of gossip, news, animal videos and bragging opportunities can be irresistible. But is it good for you? A rigorous study recently published in the American Journal of Epidemiology suggests that it isn’t. Researchers found that the more people use Facebook, the less healthy they are and the less satisfied with their lives. To put it baldly: The more times you click “like,” the worse you feel.
Facebook knows this. They cultivate it and actually use it as a feature in selling their services to advertisers. ‘We can help make your customers even more dissatisfied so that they are that much more likely to buy your goods,’ or something like that is how I imagine it going. But we don’t have to imagine. It was leaked recently that Facebook did just this very thing with their teenage users in Australia.
While this may be valuable in selling durable goods, the brands built around nondurables like Tide, Pampers, Crest and Charmin (P&G’s) or Ben & Jerry’s, Best Foods and Lipton Iced Tea (Unilever’s) don’t need to make people feel unhappy to sell their goods. In fact, if you look at their brand history it’s just the opposite. And associating their brands with a platform that makes people feel bad is something they have clearly reconsidered lately.
I believe this is exactly what they mean when they say that digital ad spend is not “facilitating the equity of our brands.” Not only is it ineffective but associating them with platforms like Facebook and YouTube that explicitly cultivate unhappiness is harming their brand equity. And it’s so much worse than just making people dissatisfied so that they spend more. In a recent article for The Atlantic, Jean M. Twenge argues that what we are witnessing today, especially among our youth, is nothing short of a mental health crisis:
Rates of teen depression and suicide have skyrocketed since 2011. It’s not an exaggeration to describe iGen [born between 1995 and 2012] as being on the brink of the worst mental-health crisis in decades. Much of this deterioration can be traced to their phones… Parenting styles continue to change, as do school curricula and culture, and these things matter. But the twin rise of the smartphone and social media has caused an earthquake of a magnitude we’ve not seen in a very long time, if ever. There is compelling evidence that the devices we’ve placed in young people’s hands are having profound effects on their lives—and making them seriously unhappy…. There’s not a single exception. All screen activities are linked to less happiness, and all nonscreen activities are linked to more happiness.
This is powerful stuff and you can be sure that major advertisers are paying very close attention to it. And it’s not just advertisers, users are not as enthusiastic as they used to be, Greenwood Investors notes, “Facebook user engagement goes into permanent decline a few years after the user signs up for the service, and the company’s Net Promotor Score is negative, meaning more people would advise friends against using it rather than getting them to sign on.” Of course they feel this way! And they don’t know the half of it.
Someone who does know at least half of it is Roger McNamee, a successful venture capitalist and early investor in both Google and Facebook. In an op-ed for USA Today, he revealed:
Facebook and Google get their revenue from advertising, the effectiveness of which depends on gaining and maintaining consumer attention. Borrowing techniques from the gambling industry, Facebook, Google and others exploit human nature, creating addictive behaviors that compel consumers to check for new messages, respond to notifications, and seek validation from technologies whose only goal is to generate profits for their owners… Former Google design ethicist Tristan Harris calls this “brain hacking.”
Just as P&G and Unilever are on the bleeding edge of the advertising world, a guy like Roger McNamee is on the bleeding edge of the consumer technology world. Clearly, he is very concerned but what should be most concerning to investors in FANG stocks is that Roger’s opinions could quickly spread to the users of these platforms. How will they feel after finding out their brains have been hacked in order to make them more amenable consumers? Well, McNamee has a piece of advice for them: revolt!
Anyone who wants to pay for access to addicted users can work with Facebook and YouTube. Lots of bad people have done it. One firm was caught using Facebook tools to spy on law abiding citizens. A federal agency confronted Facebook about the use of its tools by financial firms to discriminate based on race in the housing market. America’s intelligence agencies have concluded that Russia interfered in our election and that Facebook was a key platform for spreading misinformation. For the price of a few fighter aircraft, Russia won an information war against us. Incentives being what they are, we cannot expect Internet monopolies to police themselves. There is little government regulation and no appetite to change that. If we want to stop brain hacking, consumers will have to force changes at Facebook and Google.
This is one area where I think McNamee might be wrong, or at least impatient. There is, in fact, a small but growing appetite for regulation of these technology behemoths in Washington. The Economist recently made a compelling argument to the effect that ‘our uncompetitive markets harm our economy.’ “More than three-quarters of industries are more concentrated than they were two decades ago,” the article notes which leads to a lack of investment and greater inequality. The solution they propose to rectify this economic malady? “Toughen antitrust law.”
Perhaps Washington is listening. More people in government are starting to ask whether our antitrust law is outdated and unsuited for the dominant tech giants of the day. The Washington Post recently ran a story on this topic featuring a “note” in the Yale Law Journal that asks, “Is Amazon Getting Too Big?” From his twitter stream it would seem the president would answer in the affirmative. Even Steve Bannon, Donald Trump’s chief strategist recently proposed reaching across the aisle and joining with several democrats that want to treat Google like a regulated utility. The point is, there seems to be a wave of support growing for increased regulation of these massive and influential technology companies.
To sum up, major advertisers are taking a step back; their users are becoming more and more depressed and disillusioned; their creators and venture-stage investors are becoming appalled at what they have become and their overseers in Washington are starting to question just how much of the power they have already achieved should they be allowed to retain. Does that sound like a group of stocks that should be priced for perfection? To me, Marks was right on the mark:
Given human nature, “the best” will always come eventually to be overpriced, even for their stellar fundamentals. Thus even if the fundamentals hold up, the stocks’ performance from those too-high prices will become ordinary. And if they turn out not really to have been the best – or if their business falters – the combination of fundamental decline and multiple contraction can be really painful.
It’s very possible investors are very early in the process of realizing that the FANG’s are indeed fallible. If their businesses falter, as some of this inferential focus suggests, ‘the combination of fundamental decline and multiple contraction will be extremely painful.’