The stock market’s so-called Fear Index, the VIX gauge of implied volatility on S&P index options, traded this week at its all-time low of around 9.75%. Only on a couple of occasions during the past 30 years has VIX dipped this low, and commentators are puzzled by the apparent expectation of market stasis, despite the uncertainty of a new administration, the vagaries of Fed policy, and the worrying fact that US stocks are priced to perfection.
There’s a simple answer to the riddle: It isn’t the same market. Once upon a time the US stock market had disruptive challengers changing the economic landscape — Apple, Google, Cisco, Intel and a half dozen other upstarts. The same companies are there, but they have morphed from the equivalent of Luke Skywalker to Jabba the Hut. Tech companies used to be aggressive growth stocks, the kind that young people bought for long-range gain, while retirees stuck to less-volatile instruments like utility stocks.
The world officially went topsy-turvy this year, when the volatility of tech stocks fell below the volatility of utility stocks.
The graph shows the implied volatility of options on the S&P tech sector ETF (ticker XLK) vs. the implied volatility of options on the S&P utilities sector (XLU). Options on volatile stocks cost more than options on stable stocks, because volatility increases the likelihood of a payout. Implied volatility is backed out of the prices of traded options, and reflects investor expectations about future stability.
Why would investors expect less volatility from tech stocks than from utilities? Because they are utilities, that is, utilities with neither debt nor regulation. Power, water and sewer companies charge a stable fee to a predictable base of customers. They borrow heavily to build facilities, and are subject to public regulation, such that changes in interest rates and public policy can affect their value. Historically, though, they were widow-and-orphan stocks, the least risky sector of the equity market.
In the disruptive days of the 1990s tech boom, the volatility of the S&P technology subsector was two to three times the VIX index. Today the implied volatility of XLK, the tech sector ETF, is actually lower than the VIX. The tech companies have brought down the overall level of market volatility.
Tech companies now sit atop a virtual toll booth and impose a charge on a myriad of transactions. Like water and power companies, they have monopolies, although these monopolies are driven by the price of infrastructure and the network effect.
Google has the Internet-advertising monopoly. Microsoft has the personal computer software monopoly. Amazon has the Internet sales monopoly. Facebook has the targeted advertising monopoly. And Apple has the oddest monopoly of all: it is the vehicle by which customers assert their individuality by overpaying the largest-capitalization company in the world.
Jonathan Taplin observed in the New York Times: “In just 10 years, the world’s five largest companies by market capitalization have all changed, save for one: Microsoft. Exxon Mobil, General Electric, Citigroup and Shell Oil are out and Apple, Alphabet (the parent company of Google), Amazon and Facebook have taken their place.
They’re all tech companies, and each dominates its corner of the industry: Google has an 88 percent market share in search advertising, Facebook (and its subsidiaries Instagram, WhatsApp and Messenger) owns 77 percent of mobile social traffic and Amazon has a 74 percent share in the e-book market. In classic economic terms, all three are monopolies.”
No-one can challenge Google, because the network effect self-reinforcing: the more people rely on it for searches, the more comprehensive it becomes. Websites design their content and coding to maximize Google hits, enhancing its monopoly position. Few websites can survive without Google push ads, which means that Google can tax Internet traffic until the cost of advertising makes it unprofitable.
No-one can challenge Amazon. The physical cost of its warehouse infrastructure places a formidable threshold in front of any would-be competitor, and it is a brave business indeed that would forego Amazon’s platform for Internet sales.
That allows Amazon to charge a toll on roughly half of all E-commerce in the United States. Business startups used to have a shot at the big time. Now they are sharecroppers on the Amazon-Google-Microsoft-Facebook plantation. The monopolies allow them to make a living, but charge them a toll on every transaction steep enough to keep them small.
Product quality has nothing to do with it (as any user of Microsoft Windows will attest). The technology itself fosters a winner-take-all environment, and the winner can squeeze future competitors. As Ryan Cooper wrote recently in The Week:
“What makes Google’s search dominance profitable is network effects. Without a large internet to index, and a huge number of people looking for things online, even the best imaginable search would be worthless. The upshot here is that both Google’s overwhelming search dominance and their profitable exploitation thereof are almost wholly unmerited in terms of their actual product. Google is a fine tool, but what defines the company is luck. Its profits come from a largely unearned strategic position within a socially-created communication medium.”
Ryan Cooper, Jonathan Taplin and other commentators have suggested some form of regulation or anti-monopoly action to break up the monopolies. Google has long anticipated the day in which the sharecroppers would rise up against the plantation house, and tries to insure itself against such action by cultivating political influence.
In 2014, it spent more money lobbying than any other US company. Last year The Guardian described Google’s “revolving door” of senior government advisors hired to lubricate relations with European governments. At Barack Obama’s 2008 Democratic Convention in Denver, the Google party was the premiere event with security that rivaled that of the White House (I crashed it by means that I will not here reveal).
Most persuasive is the fact that the tech companies trade like monopolies. They walk like a duck, quack like a duck, and fly like a duck. The collapse of market volatility betrays paralysis, not confidence. A market with no volatility has no upside, either.
I do not believe that regulation or anti-monopoly action is much of a solution to the problem, although it might mitigate some of the baneful effects of the tech monopoly. The trouble is that the United States is still coasting on the impact of inventions first made practical in the 1960s and 1970s: mass-produced integrated circuits, inexpensive lasers, light-emitting diodes, and the Internet itself (a latecomer in 1983).
The rise of Microsoft, Google, Apple and Facebook could not have been anticipated 40 years ago, even after the building-blocks were already on the market. We have yet to invent the next generation of technologies that will displace the existing monopolies. And until we make concerted effort to do so, the American economy will languish in the sort of stasis that the options markets reflect.