Peter Treadway is the author of The Dismal Optimist and graciously allows Tailwinds to republish his blog pieces.
Recently, it seemed like the stock market had parked the tech sector in a penalty box of boredom while the old dogs of the Dow marched upward in a Trump rally. But last Friday, big tech revived and bulldozed the markets with super earnings and outsized one day up stock moves. In particular, Amazon (AMZN), Alphabet (GOOGL) and Microsoft (MSFT) reported third quarter earnings and guidance and the markets loved them.
Not really a surprise. Technology is accelerating at an accelerating rate. This is the transhumanist evolutionary mantra popularized by Ray Kurzweil. A mantra and evolutionary principle long-term investors should keep in mind. Investing in tech is financing unstoppable human evolution. While I make no forecasts of short-term stock moves, I have argued in this column that long-term investors need to own tech and in particular the big tech names. The big techs have the two ingredients necessary for success, huge amounts of capital and access to talent. Of these two factors of production, capital is in global abundance and talent — and that means brains — is scarce. All tech companies — and that includes companies like Starbucks (SBUX) and GE (GE) that rely on tech — are in a global war for talent. There are so many promising tech startups around the world. Everyone wants to own the next Amazon or Facebook. But that’s tougher than it used to be. The big tech companies are buying up these startups before they even get to IPO. And then of course there is Masayoshi Son’s Softbank (9984:TYO).
It will be interesting to see what city Amazon selects for its second headquarters. The media has portrayed this as a battle among the competing cities to see which one can give Amazon the most tax incentives and related fiscal goodies. But from Amazon’s point of view, the most attractive locations are likely to be ones where it can attract the most brains and talented workers. Millennium and gen X geniuses reportedly want to live in urban areas where they can walk or bicycle to work and enjoy various urban amenities. New York, Boston and San Francisco would be high on the list. Maybe Pittsburg, the home of Carnegie Mellon and its AI program? This specialized workforce reportedly doesn’t care about climate or high taxes. Otherwise Florida would be high on the list. But Florida is where grandpa lives and where you take the kids to visit Disneyworld.
I often wonder if location determines how the markets value a company. For example, I often wonder if a fine company like Corning (GLW), the maker of such tech products as fiber optic glass cables and the famous gorilla glass that goes into Apple phones, were located in one of the cool tech hotspots. Would it command a higher valuation and have an easier access to talent? (Perhaps I along with all the other urban types have misjudged the city of Corning, New York. Corning, New York was just named Rand McNally’s Most Fun Small Town in America.)
America is in a global war for brains. So far, it has been winning. Although it certainly looks like by cutting immigration, Trump and his coterie of protectionist troglodytes, want America to lose. Take a look at the names of some of America’s top tech CEOs: Satyam Nadella (Microsoft), Sundar Pichai (Google), Dara Khosrowshahi (formerly of Expedia now Uber), Jensen Huang aka Huang Renxun (Nvidia), Lisa T. Su (AMD), Ajaypal Singh Banga (Mastercard), Francis deSouza (Illumina), Francisco d’Souza (Cognizant) and, a most recent addition, Chamath Palihapitiya (Social Capital Hedosophia). While Steve Bannon and some feminists might not approve, in this non-random sample all these guys (and one woman) have Asian backgrounds and in some cases difficult to pronounce names. Presumably they have to be of extraordinary talent since they didn’t benefit from the evil “white privilege” and their grandfathers didn’t found their companies.
As I read the above list, a new investment rule suggests itself: If you can’t pronounce the CEO’s name, buy the stock. Call it Treadway’s Rule. Of course we live and invest in a global world. Outside the US, a lot of people can pronounce these CEO’s names. So this rule may only work for Americans.
Meanwhile Back in the Middle Kingdom
Chinese leader Xi Jinping has just been reelected by the 19th Communist Party Congress for another five year term as General Secretary of the Central Committee of the Communist Party of China. Mr. Xi has done a number of things on the anti-corruption front that apparently are popular in China and he seems in public to be a reasonable man with whom President Trump can deal. But the weeks leading up to the Congress saw what I consider to be steps in the wrong direction on the technology front. The emphasis — and this has to be on Xi’s orders — seemed to be o controlling information, locking up data within China and further cutting off the Chinese internet from the global internet.
Probably the most harmful idea proposed — and luckily so far it’s only an idea — is that the Chinese government take a one percent position in the major Chinese tech companies including Alibaba (BABA) and Tencent (700:HK) and appoint a government representative to their boards. The voting powers of this representative and the price paid for the one percent — details to be announced.
Such a development would decidedly not be in shareholder interest. Just imagine President Trump appointing, say Wilbur Ross, to sit on the boards of Facebook (FB), Twitter (TWTR) and Alphabet. In fact, these big American social media stocks are coming under political pressures as are their Chinese counterparts. Fortunately — however eroded — the US has a tradition of property rights and the rule of law. China, in its illustrious 5,000-year history has no such tradition.
It’s a plus that most of the top Chinese companies are traded on US exchanges. Potential troubles with US regulators might serve as a deterrent for imposition of this one percent requirement. But it should never be forgotten that, offsetting the huge potential gains, there are special risks for investors in Chinese stocks. The Chinese Communist Party ultimately is the law. Moreover, the convoluted structure of ownership that American depository receipt (ADR) investors have to put up with bears repeating. ADRs in Chinese stocks give the investor ownership of something called a variable interest entity (VIE) and not a direct ownership of the company. For example, shareholders don’t directly own Alibaba or Baidu (BIDU). Instead, they have rights to sue these companies in the British Virgin Islands or elsewhere (which hopefully don’t disappear in a hurricane).
The after-earnings performance Friday of the ADR of the Chinese search giant Baidu bears watching. While the US tech stocks were soaring, Baidu’s ADR was getting trashed, down almost 20% at one point. Company guidance for the fourth quarter disappointed the market. Bulls will argue that the ADR’s sell off was due to a one-off factor related to a prior healthcare scandal. Maybe. But this company has to operate in a country where it is not allowed to find everything that it searches for. Kind of tough for a search agent. Baidu’s now doubling down on autonomous vehicles and AI. Success there would mean big shareholder gains. Without the political risk, Baidu will probably be a screaming buy on weakness. We’ll see.
Is China Playing Fair With Batteries?
Most observers would agree that further progress on lithium-ion batteries is necessary before electric vehicles (EV) can become commercially successful. Progress is slow. It is frequently said there is no Moore’s Law in batteries. Western companies including LG Chem, Tesla (TSLA) and Panasonic (PCRFY) are or will be major battery producers. Also a number of Chinese companies have entered this field. Most observers would agree that the Western companies have a technological edge right now.
Here’s the problem. As part of its Made in China 2025 program and in response to the fogs of particulate pollution hovering over its cities, China has embarked on a major subsidy program for EVs. Nobody’s objecting to that — subsidies for EV programs are considered holy and praiseworthy under the now dominant thinking prevailing in governments around the world. But the problem is that according to press reports, the Chinese have a list of producers whose batteries are eligible to go into subsidized Chinese EV vehicles. No Western companies are on this list — surprise, surprise. China is now the world’s largest auto market and, with this subsidy program,will be the leader in EVs. Naturally, the Western battery companies want to be in this market. The current Chinese exclusionary list, if correctly reported by the press, is blatantly discriminatory and protectionist.
This is something Wilbur Ross, the protectionist American Commerce Secretary, could get his arms around. I would argue Give ‘em hell, Wilbur. Of course like so many industries this one is global. In objecting to China’s battery list, the US would be defending the interests of Japanese and Korean as well as American companies. A Steve Bannon moral dilemma.