You May NOT Pass Go

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The fireworks continued this week as we had a strong comeback in technology stocks, especially semiconductors after a risk-on PPI print.

Then on Wednesday, we had the much-anticipated CPI print coming in slightly under expectations.

We also had a landmark update when it comes to dismantling big tech.

Governments always find a way to shoot down anything that gets too big or powerful.

Google is the latest mark in the crosshairs.

This week, we’ll cover three topics: 1) The tech/NVDA comeback; 2) The CPI Print; and 3) Google’s potential breakup.

Tech Comeback/ Japan Carry Trade Unwind

Tech came back with a vengeance last week, as NVDA advanced 18.9%, SOXX up 9.8%, and NASDAQ gained 5.3%.

A lot of the recent selling has been highly systematic and followed this pattern when it comes to market flows: Discretionary Selling post CPI on 7/11 → Systematic selling post-FOMC on 7/31 → Discretionary buying post capitulation on 8/5.

The unwinding of the Japan Carry trade was a large driver of this. A carry trade unwind in the stock market occurs when investors, who have borrowed funds in a low-interest-rate currency (Japan) to invest in higher-yielding assets (US Equities/bonds), start to reverse those positions. This usually happens when interest rates in the funding currency rise (Japan hiked rates) or when risk aversion increases (concerns for recession), causing the borrowed currency to appreciate. As investors sell their higher-risk assets to repay their loans, stock prices can fall sharply, leading to market volatility. The unwinding of these trades can trigger a broader sell-off, as the rapid exit from riskier positions exacerbates downward pressure on asset prices.

As this selling was largely systematic, the market is now reevaluating fundamentals after earnings to see the durability of AI winners and losers. For now, it looks like 1) Cloud growth is alive and well; 2) Capex supercycle still has legs; and 3) AI revenue is slow off the blocks, but coming soon.

The path of least resistance may be upward in the remainder of the year.

CPI Print

CPI for July came in at +2.9% vs. expectations of +3.0% YoY.

Remember when the CPI day caused absolute fireworks in the market? It looks like those days are behind us (for now) as the last couple print reactions have been muted.

The Fed looks like it is on a glide path to lowering rates, despite resurfacing recession fears.

As to exactly what the CPI print means, Nick Timiraos (the Fed whisperer) sums it up better than I ever could:

Google’s Antitrust Case

A landmark court ruling conducted by the DOJ has found that Google monopolized the online search market, according to people with knowledge of the deliberations.

I’m having flashbacks with this one back to when Washington first tried to break up Microsoft nearly two decades ago. Quick history lesson.

In the 1990s, Microsoft was the dominant player in the PC operating systems market with its Windows OS. The company was also aggressively bundling its Internet Explorer (IE) web browser with Windows, which was seen as a strategy to edge out competitors like Netscape Navigator.

In 1998, the U.S. Department of Justice (DOJ), along with 20 states, filed an antitrust lawsuit against Microsoft. The government accused Microsoft of maintaining its monopoly by engaging in anti-competitive practices, including the bundling of Internet Explorer with Windows and making it difficult for consumers to uninstall IE.

In November 1999, Judge Thomas Penfield Jackson ruled that Microsoft had indeed violated antitrust laws by leveraging its monopoly in the operating systems market to stifle competition. It was then ordered that Microsoft be split into two separate companies: one focusing on the operating system and one handling other software products like IE, Office, etc…

However, Microsoft quickly appealed the decision. In 2001, the U.S. Court of Appeals for the District of Columbia Circuit overturned Judge Jackson’s breakup order, citing flaws in his handling of the case and the legal reasoning. The Appeals Court also removed Judge Jackson from the case due to his conduct and public statements during the trial.

Instead of pursuing the breakup, the DOJ and Microsoft reached a settlement in November 2001. The settlement imposed several restrictions on Microsoft, including:

• Allowing computer manufacturers to install non-Microsoft software on Windows-based machines.

• Requiring Microsoft to share its application programming interfaces (APIs) with third-party developers.

• Setting up an independent monitoring panel to oversee Microsoft’s compliance with the settlement.

So end results? No Breakup. While the settlement placed some constraints on Microsoft, the company continued to dominate the software industry, particularly with Windows and Microsoft Office.

Is this time different?

In his decision, Judge Amit Mehta found that Google requires device makers to sign agreements to gain access to its apps like Gmail and the Google Play Store. Those agreements also require that Google’s search widget and Chrome browser be installed on devices in such a way they can’t be deleted, effectively preventing other search engines from competing.

Additionally, Google paid as much as $26 billion to companies to make its search engine the default on devices and in web browsers, with $20 billion of that going to Apple Inc. This agreement is very likely to no longer exist in it’s current form going forward.

If the Justice Department proceeds with a breakup plan, the Android operating system and Google’s Chrome web browser are the most likely candidates for divestment. Officials are also considering the potential sale of AdWords, the platform Google uses for selling text advertising.

According to testimony from last year’s trial, about two-thirds of Google’s total revenue comes from search ads, amounting to more than $100B in 2020. This is Google’s core product and operates extremely efficient because it is imbedded across the overall product platform.

If the Justice Department doesn’t call for Google to sell off AdWords, it could ask for interoperability requirements that would make it work seamlessly on other search engines.

So will a breakup happen? Probably not. A forced breakup of Google would be the biggest of a US company since AT&T was dismantled in the 1980s.

While I view a full breakup as highly unlikely, there are going to changes to how interoperability works across Google’s suite of products.

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Cheers,

The GRIT Alpha Team

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