What we don’t know about the stock market

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The extraordinary movements of Big Tech stocks in response to small swings in their earnings show what a crazy market we find ourselves in. Uncertainty about the future of the economy in general and the technology sector in particular is extremely high. In short, no one knows anything.

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Meta, Amazon, Snap, Paypal, Netflix and Spotify were among those that made outsized moves, in part because they have premium valuations based on long-term growth expectations. Relatively small changes in the market’s best estimate of this growth rate have very large impacts on their value today, as much of their earnings potential lies far in the future.

But the magnitude of the moves is also important as investors grapple with major unknowns, any of which could hit stocks hard. Here are the four most important:

Will inflation weigh on profit margins?

Businesses are facing soaring input costs, with producer prices rising even faster than consumer inflation, itself the highest year-on-year rate since 1982. Investors narrowly focus on companies that have the power to raise prices to offset rising costs. On Friday, Clorox stock plunged 14%, the worst in the S&P 500, largely on warnings of rising costs. Amazon rose 14% in part because its expected increase in the price of a Prime subscription reassured investors that it can offset soaring delivery and labor costs.

Will the gains of the Covid era fade?

The lockdowns have accelerated the shift to many online services, but some will prove temporary. No one wants to be like Peloton Interactive,

whose home cycling training has proven a tougher sell when customers have the choice of outdoor exercise, and whose stock has lost three-quarters of its value since peaking a year ago. One of the reasons for Netflix’s steep drop after its earnings is that it turns out that people prefer real life to home movies; similarly, sales of Clorox sanitizers plummeted and PayPal’s growth slowed.

Will Big Tech eat itself?

One of the most attractive features of major online platform companies is the defensive advantage they derive from their size, known as “network effects”. People use Facebook because others use Facebook, so everyone should use Facebook. Except not so much. The Meta stock fell 26% on Thursday, mostly because TikTok is beating it in the competition for young eyeballs. Amazon and Apple have made Meta worse, Amazon because it’s choking off ad dollars at a rapid rate, Apple changing privacy settings, which Facebook has struggled with.

The competition has already touched on several other technological themes. Netflix has to spend a lot to maintain its position due to streaming wars with services from Amazon, Disney,

Comcast and others. Uber Technologies quickly took the lead in online taxi services, but it proved to be an easy model to copy and many other services sprung up around the world, competing for both customers and the drivers. The pattern is standard in technology: Microsoft has long since lost its virtual monopoly on operating systems and word processing software, while IBMit is

the dominance of PC hardware is history.

The battlegrounds of the future are cloud computing and self-driving cars, and the competition is fierce. So far, there are no signs of a slowdown in cloud-derived cash from Amazon, Microsoft and to a lesser extent Alphabet, but all are investing heavily and it could become competitive over time.

True self-driving cars aren’t for sale yet, but Alphabet, Apple and Tesla are all spending heavily on development and, in the case of Alphabet’s Waymo, some limited services. Amazon and Intel have invested in the region, and a group of traditional automakers have also made progress. Whoever cracks it first might have a big lead and deserve a big valuation, but competition, along with regulation, would surely follow.

Will bond yields continue to rise?

Growing companies are very sensitive to bond yields because much of their lifetime earnings lie further in the future than cheaper companies. Bond yields jumped again on Friday following a strong jobs report, taking the 10-year Treasury yield to where it started 2020 for the first time since. If the economy remains strong and yields continue to rise, it will be a headwind for big growth stocks.

Change the answers to any of these questions and it justifies a sharp decline – in most cases – in the price of the stocks exposed. The number of big price swings so far this earnings season could be because the exit from the pandemic creates turning points in all of these issues at once. But one question that nags at me is whether volatile prices point to a deeper problem that could lead to much broader market issues. But like everyone else, I don’t know.

Write to James Mackintosh at [email protected]

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