Markets plunge, GDP gains hide near zero growth

Plus the Big Tech wars, election portends and China’s next Five Year Plan

Welcome to another edition of Contention! This week we have about eight minutes of cloud computed dissident business news. This week:

  1. Bad news prompts biggest crash since March

  2. Big tech’s gains fail to hold back market freefall

  3. Microchip boost launches scramble for market share

  4. Rapid round: Senators grandstand, China plans, WTO stalls, elections loom

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Bad news prompts biggest crash since March

U.S. equity markets experienced their worst week since the March coronavirus crash, with the Dow losing 6.5%, the S&P 500 5.6%, and the Nasdaq 5.5%. The “holding pattern” we described last Monday seems to have given way to a significant market downturn despite ostensibly positive economic news during the week.

A record surge in COVID cases, new lockdowns in Europe, election fears, and the final end of stimulus talks all prompted a broad-based selloff in stocks, gold, and cryptocurrency. Stock declines did not fuel a gain in bonds -- as they typically would -- as investors rushed into cash, much like March’s collapse. The dollar responded by breaking out of its downward trend.

The moves reflect market fears around fundamental risks, ignoring surface-level positive economic news:

This record GDP performance was not all that it seemed, however. First, 33.1% is an annualized number -- if the economy grew at this rate for a full year we would have 33.1% growth, but that is not going to happen. The economy actually grew by 7.4% compared to the quarter before, when the economy dropped 9% from the quarter before that -- the worst decline ever.

Obviously 7.4 is smaller than 9, meaning that the economy is still in a deep hole, the biggest since the Great Financial Crisis. GDP would have had to increase at an annualized rate of 46% to get back to par, or by 63% -- i.e. roughly twice as much -- to get back on the economy’s pre-2020 growth path.

It’s even worse than that. The GDP number reflects quarter-on-quarter change, but April’s shutdowns skewed the Q2 numbers sharply downward. The economy bounced back to its current state in May and June, but because April was so bad, the Q3 GDP looks bigger despite five months of coasting. Even zero growth would have resulted in a 29% annualized uptick from the April-skewed quarter before.

The fact that traders couldn’t justify bidding up prices on the surface-level good news indicates just how deep the problem goes right now. Stay tuned to see if reality continues to overwhelm their recent fantasies.

Big tech’s gains fail to hold back market freefall

Another sign of the market’s deep-seated worries last week: even generally positive earnings reports for the tech megacaps -- Facebook, Amazon, Apple, Microsoft, and Google parent company Alphabet -- could not pull the major indexes out of their decline.

Tech stocks led market losses at the week’s end, with all five of the tech giants reporting earnings last week:

  • Apple edged out earnings and revenue expectations, but saw a 20% year-over-year decline in iPhone sales.

  • Microsoft also beat earnings expectations, but nonetheless slipped as it predicted less future revenue than analysts expected.

  • Amazon crushed earnings expectations, returning $12.37 a share versus $7.41 predicted. Revenue gained 37% year-over-year.

  • Alphabet returned to growth after its first ever decline last quarter, beating earnings expectations with $16.40-a-share versus $11.29 predicted.

  • Facebook reported a 22% growth in ad revenue despite the “Stop Hate for Profit” campaign. The company nonetheless reported a decline of two million daily active users in the United States and Canada.

Like any oligopoly, competition between the companies has now become far more significant than any competition between the megacaps and the market at large. The most important ground for this competition: cloud services, where Amazon, Microsoft, and Google now make up 60% of the global market.

  • Amazon Web Services (AWS) -- commanding 33% of the cloud market -- saw 29% growth year-over-year. The segment brings in only 12% of Amazon’s revenue, but accounts for half of its profit.

  • Microsoft’s Azure -- second place in the market with 18% -- grew revenues by 48%.

  • Alphabet announced that beginning next quarter the company would break Google Cloud -- responsible for 9% of the market -- into a separate reporting segment for the first time.

Not to be left out of the intra-oligopoly competition, FT reported last week that Apple appears to be building its own search engine, leveraging data from its one billion users to develop a Google alternative. The recent U.S. antitrust lawsuit against Google is apparently benefitting yet another tech giant -- Apple -- not outside entrepreneurs.

These five firms now touch almost every transaction in the global economy in one way or another. As the crisis continues they will gobble up only more market share, condensing value from around the world into the hands of their investors -- concentrated in the world’s wealthiest enclaves. For last week, however, even their growing power could not escape an accelerating market decline.

Microchip boost launches scramble for market share

U.S. chipmaker AMD announced a $35 billion acquisition of rival Xilinx last week, while Bermuda-based Marvell bought Inphi Corp for $10 billion -- the latest moves in a $100 billion wave of consolidations in the global semiconductor industry.

Despite headlines focused on higher-profile issues, the rapidly changing shape of the semiconductor sector may be the most important topic in the global economy today.

Already a booming industry, the rapid shift to remote work has driven new demand for chip-powered computers and data centers, with North American semiconductor sales up 40% year-over-year in September. Chip companies have in turn seen soaring stock prices -- AMD has gained 126% in the last year -- providing rich collateral for leveraged acquisitions.

Strong equity performance also makes all-stock deals -- like the AMD-Xilinx purchase -- attractive to shareholders on both sides of the transaction.

Both deals come as cloud computing has focused attention on data center power, with AMD’s purchase accelerating their competition with industry titan Intel. Intel’s stock fell earlier in the month as its enterprise and government server sales fell 47%, taking the segment down to $5.9 billion. AMD’s equivalent business only generates $1.13 billion, but is up 116% for the year.

Intel has now fallen behind much hotter rivals Nvidia and Taiwan Semiconductor Manufacturing Company (TSMC) in terms of market cap. The latter is especially significant, as markets have treated the two major chip fabricators as zero-sum competitors. And this is where the business rivalry turns geopolitical.

Before this year, China’s Huawei was TSMC’s second-largest customer (after Apple), but U.S. export licensing restrictions have rocked that relationship. New reports last week indicate that the U.S. is likely to allow the Taiwanese fabricator to still sell 4G mobile and PC chipsets to Huawei, but will block the chips needed for 5G stations and the latest generation of data centers.

Huawei is now scrambling to develop a “not-made-in-the-USA” supply chain before they run out of stockpiled chips. Not helping things: an opportunistic rush into the sector by unprepared firms prompted by extraordinary Chinese state investments, leading to a number of debacles. Beijing responded in October by warning of consequences for companies trying to get into the sector despite having “no experience, no technology, and no talent.”

Last week we said that the future of global investment hinges on whether or not the United States and its allies can hold back rising Chinese leadership. If China is dependent upon U.S. chip technology, the legacy superpowers win. How each country’s semiconductor industry adapts to a changing economy will decide that struggle. Stay tuned as Contention follows developments to come.

Rapid Round

Tech hearing sinks into distractions

On Wednesday, Facebook CEO Mark Zuckerberg, Alphabet CEO Sundar Pichai and Twitter CEO Jack Dorsey testified before a U.S. Senate committee. The hearing was supposed to be about Section 230 -- the law which allows internet platforms to avoid liability for their users’ actions -- but the law did not come up until nearly three hours into the hearing.

Instead, Republican senators focused their questions on alleged bias against right-wing users. Despite being 23 times smaller than Facebook and 34 times smaller than Alphabet, Twitter’s Dorsey got most of the committee’s attention for suppressing a New York Post story about Hunter Biden -- son of former Vice President Joseph Biden.

Dorsey, for his part, offered some proposed reforms for Section 230, including allowing users to choose the algorithm that drives their content selections. Pichai warned of unintended consequences for any major changes, while Zuckerberg likewise acknowledged the need for reforms.

China prepares next Five Year Plan

Last week the Communist Party of China’s Central Committee met to draft the first outline of the country’s 14th Five Year Plan -- a comprehensive strategy for the country’s economic development through 2025. The plan focused on the country’s efforts to guarantee employment, redistribute income, improve the country’s social security programs, and advance the population’s consumption potential.

The plan notably dispenses with traditional GDP targets and focuses more on the quality of economic growth, putting the country on a trajectory towards “moderately developed” country status -- with per-capita incomes comparable to Spain, Israel, or South Korea -- by 2035.

The party expects to do this through a “dual circulation” strategy proposed by President Xi Jinping earlier this year. The strategy emphasizes increased consumer power, which the Five Year Plan will encourage through internal migration and land use reforms. The plan also focuses on domestic semiconductor development and internationalization of the yuan.

WTO top job hits U.S. roadblock

The United States upended the nearly finalized effort to appoint a new director-general of the World Trade Organization (WTO) last week by announcing its opposition to the leading finalist, Ngozi Okonjo-Iweala.

Okonjo-Iweala -- a former Nigerian finance minister and managing director of the World Bank -- has the support of the European Union, Japan, and a majority of other countries in a process historically decided by consensus. U.S. Trade Representative Robert Lighthizer announced his objection to Oknojo-Iweala on Wednesday, throwing his support behind the other finalist for the job -- South Korea’s Yoo Myung-Hee.

The position is open because the last director-general, Brazilian Roberto Azevedo, resigned more than a year early in the face of U.S. blocks on appellate judges needed to resolve disputes. The “chaotic” and “improvised” manner of Lighthizer’s announcement against Okonjo-Iweala led other WTO officials to speculate that it was another move to sabotage the body. U.S. President Donald Trump’s nationalist economic policies run contrary to the organization’s charter.

Okonjo-Iweala, on the other hand, would fit the WTO’s historic purpose well. As Nigeria’s finance minister she helped oversee a massive privatization of public assets, negotiated a painful $12 billion payout to the “Paris Club” of rich nation creditors, and helped usher in major fuel cost increases for the country’s poor.

Analysts: election chaos points to market losses

Markets registered growing concerns about the U.S. election process and outcomes, as economic indicators, original quantitative analysis, and market observers predicted a possible tightening of the contest. Polls still indicate a large advantage for former Vice President Joseph Biden, but the U.S. political system is explicitly designed to prevent majority rule.

A likely sabotage of the country’s postal system has led to major drops in on-time mail delivery, with Philadelphia -- the political lynchpin of the pivotal state of Pennsylvania -- experiencing a 46% decline. Advocates now warn that it is too late for mail ballots to arrive on time. Turnout among Black and Latinx voters is far below expectations, with the Biden camp rejecting community calls to invest in outreach there.

Votes may be close enough in enough states to throw the decision to unelected federal courts, with three sitting Supreme Court justices -- Chief Justice John Roberts, and Associate Justices Brett Kavanaugh and Amy Coney Barrett -- having worked for the Bush campaign in 2000’s disputed election. Kavanaugh signalled in a decision over Wisconsin’s voting procedures last week that he would recognize slates of electors appointed by GOP legislatures against the wills of their voters.

Can Biden win by a wide enough margin in the right states to prevent this? Markets hope so: the S&P 500 lost 8% and the Nasdaq 24% during the 2000 debacle, and analysts now predict 5-20% losses depending on the severity of the dispute. Bank of America predicted a 0.5-1% loss in GDP due to a multi-week crisis, but markets are unlikely to register any difference between subsequent administrations.


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Photo Credit: U.S. Congress