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A very modern feudal system?

Some of us recall the sense of excitement into the 1999 year-end.  “Party like it's 1999” was the famous line from Prince’s number one hit single and the stock market certainly rallied, led by the so-called stocks made up of around 37 leading firms in the technology, media, and telecommunications sectors. The promise of a digital future on fast forward was rudely interrupted by the market correction that followed.  However, the long-term trend has certainly played out and delivered its potential both to shareholders of the successful firms and by reshaping our lives in some significant ways as we travel forwards deeper into the 21st century.  The technology phenomenon is an example of a classic Kondratiev wave - A Kondratiev Wave is a long-term economic cycle in prices, believed to result from technological innovation, that produces a long period of prosperity.

Rolling the years forwards to 2024 technology companies and their share prices continue to incite superlatives.  The so-called Magnificent Seven collection of firms developing artificial Intelligence have seen super dominance in terms of stock market performance.  Apple’s market capitalisation is larger than the entire German stock market. 

Likewise, the market capitalisation of the Magnificent Seven firms is larger than the stock markets of the UK, Canada and Japan combined!  The underpinning factors supporting the trend are important and should be understood more clearly as we enter the next phase of development, and perhaps the beginning of the next Kondratiev wave.  Let’s dig in. Source Roots for US dominance of the global technology sector can be traced back to the post war Breton Woods agreement which established American global economic dominance and the reserve currency status for the US dollar.  The 1950s saw US firms dominating the manufacture of everything from motor cars to washing machines as technological innovation switched away from military to a broader base.  The flood of dollars into the United States from international trade was tremendous and built a dominance in the industries that really matter – notably technology.  

Look globally and you see giant technology firms present in the United States and China only.  The UK, Europe and other so-called developed markets have no presence.  This creates a modern-day feudal structure which underpins growth and share prices for the dominant feudal barons.  A feudal structure is one where the entity at the top of the hierarchy exacts an ongoing charge, a type of rent from those accessing the services and infrastructure it supplies.  In the dark ages peasants paid a rent to the feudal baron for the privilege of farming the land and growing crops.  The landowner “robber baron” would exact further taxes when the harvest was sold at market.

Source : Today most of us are addicted to our smart phones – look around at people on public transport, cafes, and even restaurants.  We shop online and the likes of Alibaba and Amazon take a disproportionate market share.  They manufacture absolutely nothing, yet they take around a 40% share of product charges sold on their global platforms.  Further, they charge users a monthly subscription for accessing the Amazon Prime service package.  Our smart phones can listen to us and suggest products and services we might wish to purchase.  Our whereabouts is tracked, our phones know which shops we use and where our retail habits take us.  Some of us pay to have a digital assistant called Alexa who listens intently in our homes to every word uttered.  This data is collected and sold onwards – cookies, as they are innocently called are a vast money spinner for the technology feudal barons.  Of course, we know this only too well and only a tiny number of people have opted out.  We live in a connected world where access to essential services come via the internet – opting out is not viable in a modern connected world. 

Mr Elon Musk now ranked number 1 or 2 wealthiest human on the planet cleverly bought Twitter (now rebranded X) for $44 billion – a tidy sum but considered reasonable given the medium-term plan to evolve the service into an “everything platform” with access to a long list of goods, services, and a digital chat room for the world.  Links to other Musk owned enterprises at preferential rates or via an enhanced service will follow.  As Tesla, the automotive sister company moves into self-driving taxis (not as far away as you might think) an access point via the X platform will be made, routed by Starlink the Musk owned company already providing internet access to many around the world courtesy of satellites positioned in earth’s orbit delivered by SpaceX, a company owned by Mr Musk. 

The prospect of self-driving cars pioneered by Tesla is rapidly approaching.  Each Tesla car has seven cameras and a recording device which tracks road, traffic, and driver behaviours to a remote computer with machine learning capabilities – learning how to drive in local road conditions over time.  We the customers provide this intelligence and knowhow completely for free – the product provider (in this case Tesla) charges us for accessing their new products which are built using our data.  A canny business model indeed.

The new feudal barons are clever in many ways – they locate head offices in jurisdictions which allow them global access to the highest calibre staff to deliver ongoing development to their products and services.  Yet, simultaneously help them avoid paying tax.  In 2023 Amazon exacted $37 billion in revenues from Germany and $33 billion from the UK and yet did not pay corporate taxes, thanks to a domicile in Dublin affording such a policy.  These colossal savings are typically ploughed back into further research and development to deliver higher revenue in future years.

Annual net sales of Amazon in selected leading markets from 2014 to 2023(in billion U.S. dollars).

One would not expect a jonny-come-lately with no manufacturing heritage or deep brand equity to outpace established players with a century of history and a loyal customer base.  Surely this must be a flash in the pan, a classic stock market hype akin to the tulip bulb share price bubble of 1637.

Germany once the powerhouse of quality automotive manufacturing for decades is in steep decline.  BMW, Volkswagen Audi Group, and other German brands rushed to launch battery electric vehicles so they might compete with the likes of Tesla and other newcomers.  However, their share prices and progress are poor on a relative basis – why?  VW products, for example, are not connected to the digital infrastructure in the same way as the modern-day technology feudal barons.  The stock market is dispassionate in its clear support for the new feudal approach to capitalism.  For those who point solely to traditional valuation metrics suggesting a crash in technology share prices anytime soon, unless “something has changed”, we reply, yes it would certainly appear so, based upon the evidence that modern feudal digitally connected companies do indeed command a structurally higher stock market valuation.

The second, and only other giant technology home is China.  Their leading companies comprise Tencent, Bidu, Alibaba, and Ping An to name a few.  The complexity of the Chinese ownership structure makes it difficult to be precise, however, the integration with state sponsored banking and finance makes for a powerful combination offering perhaps an advantage over US based peers.  The Chinese Communist Party’s control has shown itself in powerful fashion, banning online gaming for younger age groups and rationing exposure for the very young.  However, China’s demographic issues comprising a shrinking and an ageing population point to lower GDP in the future – unless technology, including machine learning and artificial intelligence are pushed to the fore.  We expect this to unfold.

So, to wrap up, the world has only 2 homes for giant technology firms – the United States and China.  The US remains ahead for now.  Trillions of dollars flow into the technology industry each year in terms of revenues, “feudal rents”, and investment.  The valuation of such firms probably does represent a new phenomenon based upon the interconnected cloud-based infrastructure creating a dominant feudal landscape in the 21st century.  We look to the future of machine learning and artificial intelligence with caution but inevitably optimism.  Our lives will continue to be enriched and the super importance of data is here to stay, at least a while longer as the Kondratiev wave continues rolling forwards.

Artificial Intelligence offers enhancements to productivity and possibilities still beyond our imagination/comprehension. But there are risks and downsides to navigate (some still see it as the biggest existential threat to humanity).

From a stock market perspective, the hype can push prices to extremes, as we saw with the boom.  Ride the wave but be careful - corrections can be painful and may need navigating.  

Written by the Alpha Beta Partners Investment Team.

All sources Bloomberg unless otherwise stated. IMPORTANT NOTICE This is a marketing communication from Alpha Beta Partners a trading name of AB Investment Solutions Limited. Registered in England at Northgate House, Upper Borough Walls, Bath BA1 1RG. AB Investment Solutions Limited is authorised and regulated by the Financial Conduct Authority. Reference No. 705062.

This material is directed only to Financial Advisers in the UK and is not an offer or invitation to buy or sell securities. Opinions expressed, whether in general or both on the performance of individual securities and in a wider context, represent the views of Alpha Beta Partners at the time of preparation. They are subject to change and should not be interpreted as investment advice.

You should remember that the value of investments and the income derived there from may fall as well as rise and your clients may not get back the amount that they have invested. Past performance is not a guide to future returns.


Important Information

This material is directed only at persons in the UK and is not an offer or invitation to buy or sell securities.

Opinions expressed, whether in general, on the performance of individual securities or in a wider context, represent the views of Alpha Beta Partners at the time of preparation. They are subject to change and should not be interpreted as investment advice.

You should remember that the value of investments and the income derived therefrom may fall as well as rise and you may not get back your original investment. Past performance is not a guide to future returns.

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