The high-flying technology sector exploded from the March low during the risk-off period caused by the global pandemic. The hot lights of Washington DC and European regulators have been on the leading technology companies over the past months.
Lower corporate taxes under the outgoing Trump administration have fueled incredible profits for the tech sector. Meanwhile, the leading companies have amassed enormous cash stockpiles making it virtually impossible for competition to thrive, raising antitrust issues. Technology companies have unprecedented access to data that increases their power in running businesses and shaping opinions. Moreover, some of the founders have seen their fortunes grow at an exponential rate with share prices. Jeff Bezos is now the world’s wealthiest period, with a net worth of almost $200 billion. Other founders have accumulated enormous wealth.
On November 7, President-elect Joe Biden declared victory in the November 3 election. On November 9, Pfizer (PFE) announced that its COVID-19 vaccine has a 90% effectiveness. The stock market soared, but while the DJIA, S&P500, and Russell 2000 indices all posted impressive gains, the tech-heavy NASDAQ fell over 1.5% on the session. We could look back on Monday, November 9, as a watershed day in the stock market and for the technology sector. In 2021, higher taxes and more regulations could remove some of the tech sector’s power, which has bipartisan support in the US.
The Invesco QQQ Trust (QQQ) holds a portfolio of the leading technology stocks. We could see a significant correction in the QQQ over the coming year as the pressure mounts to put a leash on the growing influence and earnings power of technology companies.
Twitter becomes more aggressive
Twitter (TWTR) and Facebook (FB) are two of the leading social media platforms. In the leadup to and aftermath of the 2020 Presidential election, we have seen a crackdown on some of the content on websites. I am not making any value judgments on President Trump’s ongoing tweets over the past weeks. However, Twitter has become aggressive in qualifying messages by posting the following on many of his tweets:
Twitter, and other social media platforms, have made a conscious decision to qualify statements. I believe the move is an insult to their users who should be informed enough to make individual judgments or form opinions. Moreover, the qualifications could influence opinion as it amounts to a form of censorship and could run contrary to the first amendment to the US constitution, which protects freedom of religion, speech, press, petition, and assembly. Interpreting the first amendment is no easy task, as many court cases have attempted to define the limits of these freedoms. Twitter and other platforms have decided to take a position and use methods that censor or qualify messages.
Whichever side of the political aisle you may be on, the actions by platforms that play a substantial role in information dissemination has wide-ranging consequences for first amendment freedoms. Bias in news reporting is prevalent, which is another issue when it comes to shaping public opinion. Censorship or qualifications by platforms could run contrary to current liability protections as it involved making subjective instead of objective decisions.
Section 230- Will Democrats care?
In a recent hearing of the Senate Commerce Committee, Senator Ted Cruz asked the Twitter CEO, “Mr. Dorsey, who…..elected you? And who put you in charge of what the media are allowed the report and what the American people are allowed the hear?” Twitter had decided to block the posting of a New York Post report making corruption allegations against President-elect Joe Biden. While Senator Cruz accused Twitter of “behaving like a Democratic super PAC (political action committee)” and “silencing views to the contrary of your political beliefs,” the issue could be a double-edged sword for both sides of the political aisle in the future. The rising power of social media is an issue that transcends the tweet qualifications or decisions to block a particular item in a newspaper.
Section 230 of the Communications Decency Act provides that “No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information or content provider.” Mr. Dorsey, Mr. Zuckerberg, and other founders and CEOs of social media platforms will argue that they act in the public’s best interest. However, decisions to censor or qualify statements on platforms could run contrary to first amendment rights and could cause them to surrender their liability protections under Section 230. The process of editing or commenting on posts requires taking a position on that content.
Time will tell if a bipartisan agreement on the rising power of technology companies leads to protecting first amendment rights and prevents those companies that seek Section 230 protections from interfering with any posts. Mr. Dorsey is also the founder and CEO of Square, a payments company that recently made a $50 million investment in Bitcoin. Both sides of the political aisle in Washington DC have resisted the digital currency as its rise would diminish the government’s control of the money supply. The power struggle took center stage when Facebook’s Mark Zuckerberg testified on FB’s role in the Libra digital currency. Democrats and Republicans urged FB to back off its plans.
Technology oligarchs have a lot of power, and this could make them targets
Jeff Bezos is the world’s wealthiest period, with a net worth approaching $200 billion. Mr. Bezos made his fortunes on the spectacular success of Amazon (AMZN). Owning the Washington Post only extended his sphere of influence. The other leaders of the technology sector are billionaires. While Senator Cruz attacked Twitter for being a PAC for Democrats, the technology sector could face its most significant challenge from Democrats as they take power with control of the House of Representatives and the White House in January 2021.
One of the most significant issues addressed by Democrats has been the division of wealth in the US. President-elect Biden has pledged to increase taxes on the wealthy and corporations. The many social programs that Democrats support will require massive funding, which could push taxes higher on the US’s wealthiest people and cause net worth’s to decline precipitously.
The leading technology companies control valuable data, which translates to tremendous political and economic power in the US and worldwide. Progressive Democrats favor breaking up many top companies into smaller ones to eliminate data control and foster more industry competition. Moreover, they could face expensive antitrust charges because of their dominant positions.
The technology oligarchs and their companies are likely to face significant changes over the coming months and years because of the political environment in Washington DC and Europe, which has already sought to put limits and level sanctions on the high-flying sector.
The companies that could face the most substantial changes are the FAANG stocks and the other technology leaders.
The gains have been impressive, but higher taxes and increased regulation are coming soon
The fund summary and top holdings of the Invesco QQQ Trust (QQQ) include:
Source: Yahoo Finance
QQQ is a highly liquid product with $129.99 billion in net assets and almost 49 million shares changing hands each day. It charges holders a 0.20% expense ratio. Since the March low, QQQ has been the place to be in the stock market.
As the chart shows, after reaching a low of $164.93 on March 23, the QQQ rose to a high of $303.50 on September 2, a rise of an incredible 84% in a little under six months. At $288.40 on November 12, the QQQ was near the highs and still 75% higher than the March bottom. Technology has been the place to be for investors and traders since the end of the first quarter of 2020. However, many of the sector members have seen their stocks rise to what could be unsustainable levels for 2021.
Rising corporate taxes under the Biden administration will eat into earnings. Increased regulation that may destroy data franchises and dominant market positions could cause a brutal correction in technology. The products that have made technology companies soar will continue, and innovation will continue over the coming years. However, valuations are at levels that make them highly susceptible to sudden sharp downdrafts.
In many ways, issues like censorship on social media platforms, anticompetitive practices created because of massive cash hordes, data control, and embracing digital currencies that challenge government power make for a problematic horizon. Many of the companies and their leaders have become easy targets for politicians on both sides of the political spectrum. Many, like Senator Cruz, will use their platforms to cast them as villains.
The technology sector founders and leadership has been working within a system that did not keep pace with their success and could dramatically shift. Wealth creation may have created a certain level of arrogance and hubris. Hubris is a quality of excessive price or self-confidence. In the tragedy of Oedipus Rex, Sophocles taught that hubris is often a prelude to failure.
Puts on QQQ to protect portfolios as the volatility index drops
The trend is always your best friend in markets, and it remains higher in the technology sector. Therefore, aggressively shorting tech stocks has been a losing proposition. Meanwhile, the landscape could experience a sudden shift for the high-flying dominant companies. The VIX index measures the implied volatility of put and call options on the S&P 500 stocks. The leading stock market indices tend to move together. While technology stocks far outperformed the S&P 500 since the March low, the index still appreciated by over 66% as of the latest high on November 9. The VIX tends to move lower during rallies and higher when the S&P 500 corrects lower. The stock market typically takes the stairs higher and an elevator to the downside. Put options on the QQQ could be the optimal approach for 2021, but timing is a significant factor as options become costly when volatility levels move higher.
The chart shows that the volatility index declined from a high of 41.16 on October 29 to 25.35 on November 12. Volatility dropped over the past two weeks, making call and put options less expensive.
With the QQQ trading at $288.40 on November 12, a December 2022 $280 put option settled at $39 or $3900 per contract as each represents 100 shares of the QQQ Trust. If the QQQ is below 241 in December 2022, the put option holder will earn a dollar-for-dollar profit on the long put position. A sudden downdraft in the QQQ is likely to make the option appreciate substantially on the bearish price action and the increase in volatility during a corrective move. The option will experience time decay, meaning the longer the market takes to decline, the more the option premium will shrink.
Those holding portfolios with profitable tech share long positions could use the QQQ puts as a hedge. Market participants looking for a correction in the sector in 2021 could use a put option as a speculative tool. A scale-down approach to buying QQQ puts could be the optimal approach if the volatility component continues to decline, and the technology rally continues over the coming weeks and months. The put option has limited risk. When you purchase an option, the only risk is the premium you pay.
The technology sector has been a bullish beast since March. Valuations are at levels where a correction would be logical. Governments have already signaled that the power and influence of the sector are getting out of hand. A mixture of taxes, regulations, and hubris could make 2021 a challenging period for the stock market’s best performing sector in 2020. It is not unusual for the leading sector during one period to become the worst during the next. Now could be the perfect time to take a limited-risk position to prepare for a tech wreck in 2021.
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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.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.