Nasdaq crash: Why are Alphabet (GOOGL), Facebook (META), Amazon (AMZN) shares falling?

2022 hasn't been a great year for the stock markets, especially for tech stocks. The tech-heavy Nasdaq index has fallen more than 30% since Jan 2022 and falling into a bear market due to interest rate hikes, rising inflation, macroeconomic uncertainty, global pressures and the strong US dollar. Nasdaq fall intensified late last week due to weak third quarterly results from mega tech players like Alphabet, Microsoft, Facebook (Meta) and Amazon.

How have the Top 20 Nasdaq stocks performed:

Figures as of Nov 9 2022

Why Are US Tech Stocks Falling?

The markets have an eerie relationship with tech stocks. They pamper and cheer them during the “good” times and simply seem to punish them when predicaments and uncertainties arise. The Nasdaq has fallen by over 31% since the start of this year. And some of the world’s most valuable tech stocks have had a major role to play in the downfall. 

Markets are fueled largely by forecasts and expectations. Companies that meet what analysts expect are cheered, while those that fail to meet expectations are hammered. The same works even for businesses. At this point in time, we are reminded of what Mark Zuckerberg, the boss of Meta (earlier Facebook) had to tell his employees while laying off more than 11,000 of them. The CEO had predicted that soon after the pandemic began to recede, there would be a huge surge in the growth of e-commerce.

The prediction comes as several companies realized that digital adoption was the future (which stands to date) and that it is better to migrate as soon as possible. Now, this was good news for Mark and his peers at Silicon Valley. As more businesses go digital, they would even advertise digitally. However, things took an unexpected turn. No one, including the best of analysts and forecasters, predicted the Russian aggression against Ukraine in February this year. While inflation was high, thanks to the easy money policy adopted by the Federal Reserve during the pandemic, the Russian aggression added salt to the injury. 

As costs began to skyrocket, the same businesses that had gone digital, now looked to conserve costs. When it gets difficult to keep operations running, certain expenses like advertisements and promotions can be easily sacrificed. Mark Zuckerberg’s forecast bubble burst. 

Facebook hired around 87,314 people in the 12 months ending September. That translates to an increase of 28 percent in the overall staff count. (Yes, this was in accordance with Mark’s ambitious plans.) Further, the company had even increased its contributions to its metaverse project (Reality Labs) hoping that investors would have the stomach to bear the losses of its futuristic venture. Investors, nevertheless, failed to relent.

What is even more concerning?

Now let’s shift our focus to another mega-tech company, Amazon. One of the pillars of the internet is storage. You cannot function smoothly without having your database stored in a cloud server. And who rules this domain, you may ask. Of course, it is Amazon Web Services (AWS)! (owns 33% of the entire cloud market as of Q1 2022). In a rare instance, Amazon, in its third-quarter earnings reported a slow rate of growth in its cloud business. AWS used to be among Amazon’s fastest-growing and most profitable businesses. The fact that even AWS isn’t really expanding, is quite telling. And that the firm pausing its hiring in the AWS segment is even more telling.

There are several other firms that have joined the layoff bandwagon, as their business conditions seem rather uncertain. 

Connecting the threads

While most e-commerce firms look distinct on the outside, a closer look would reveal that most of them are similar. Also, a majority of them face the same bottlenecks. These can broadly be summarised into three forms.

The Network Effect

Most tech companies (especially startups) place a lot of faith in the power of the network effect. What is it though? Network effect or flywheels” (according to Silicon Valley lingo) is the idea that as the number of users of a particular product increases, the total value of the product also increases. It is simple. Let’s say you like a specific app on the App Store or the Play Store, you would most likely suggest this to any of your friends or family member who in turn would get impressed by the app's performance and pass the baton. Companies aim to hit a specific user base, after which the flywheel powers a self-perpetuating cycle of growth. Are there any limits to it? Think of Uber. If it wants to reduce the average wait time for both riders and drivers, it would have to keep adding from both ends. However, the company hit a point where it encountered diminishing returns to scale. Reducing the wait time from two minutes to just one minute would require twice the number of drivers. Right? But how much of a difference is it going to make to the user? Users aren’t really going to be impressed by negligible differences that cause trouble for the large number of drivers who aren’t getting as many riders as they had thought. 

What about Netflix though? Netflix had always believed that the vast amount of user data about their listening and viewing habits would give it a strong bastion in terms of top-notch content. However, competition from other streaming providers as well as flops like “True Memoires of an International Assassin”, which apparently raked a rare 0% score on Rotten Tomatoes (a review website), became a worry. 

Low Entry Barriers

For a long time, several e-commerce companies that had gained the early mover advantage thought that the entry barriers that they had created by the advancements in technology would act as a huge boon. Thanks to the smartphone and the cloud-computing boom, several local firms that were much smaller in comparison to these multinational companies began to rise and posed a threat to their dominance. For companies such as Netflix, certain deep-pocketed rivals (Disney looks to spend close to $30 billion a year on content generation) have caused trouble. Netflix aims to spend around $17 billion this year. As this race to “who spends more” intensifies, customers could face the brunt. Also, this is one of the reasons that Netlfix’s cash flow is just 6% of its overall revenues.

Distribution Platforms

The third factor is that most e-commerce companies rely heavily on distribution platforms that aren’t their own. The disproportionate reliance on Apple’s App Store and Google’s Play Store is a huge threat to their business models. Some of these companies have even complaints against these bigger tech companies. Meta had even forecast that close to $10 billion of its revenues could be lost to the new privacy features introduced by Apple. 

Though by and large, most e-commerce companies do not face issues due to these three factors by an equal measure, it does, however, affect them to varying degrees. 

Things might change in the near future. As we are already witnessing, Netflix finally giving up its belief that an ad-free experience could be the differentiator. The company is soon going to roll out its ad-based low-cost plans as well as eke out something from those who love to share their Netflix accounts with others. 
Apart from these idiosyncratic factors, the Federal Reserve’s monetary policies would play a huge role in the future of tech stocks in the periods to come. We had written about it here.

Key Takeaways

• A major reason why most of the tech stocks are falling is that as high inflation persists, many businesses have cut down on their advertisement spending in order to save costs. 
• Since most of these big tech firms rely on advertisement revenues, their profits are now being impacted.
• Also, the post-pandemic digital boom had lured companies into spending extra money on several new ventures or hiring tech talent at attractive salaries, however, the rate hikes by the Federal Reserve and high inflation resulted in less spending by businesses on digital ads which in turn translated as a drop in revenues for these firms.
• Over-optimism on the advantages on offer by network effects, low entry barriers due to the surge in cloud computing services, and dependence on platforms to host their apps started to cause problems for various tech companies.

What should you do now?

As per analysts, investors shouldn't sell their shares in a panic but instead buy additional shares, anticipating that low-priced stocks will eventually recover and yield significant gains. Experts advice investors to have long-term strategic asset allocation that makes sense for them and stick with it. Tech stocks could bounce back by next year, but it will be a ‘volatile ride', says Citi.

Also the US economy is slowly picking up. Consumer spending expanded in the July-September quarter, the US economy returned to growth snapping 2 consecutive negative GDP quarters and US inflation for October rose to 7.7% on year, its smallest on-year gain since Jan 2022.

Experts suggest, amid high interest rate environment, growth stocks in cloud, e-tailers and software sectors may continue to remain under pressure due to concerns over their valuation. Companies which can maintain healthy margins due to their pricing power will be relative outperformers. Avoid lump sum allocation and adopt a more staggered approach while investing in equities over the next few months. US stocks SIP’s are the best way to take advantage of volatility. Invest through INDmoney at zero additional cost.

This is not an investment advisory. The blog is for information purposes only. Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements, risk tolerance, goal, time frame, risk and reward balance, and the cost associated with the investment before choosing a fund, or designing a portfolio that suits your needs. The performance and returns of any investment portfolio can neither be predicted nor guaranteed.