US Equity Markets, Technology, Innovation and Wage Growth: Part 1

Majestic Benjamin Franklin ” Tell me and I forget, teach me and I may remember, involve me and I learn.” Founding Father United States of America

VIX Index also known as fear index reflects the market sentiment in a country. A higher value of VIX shows a high probability of uncertainty in the market usually reflected during crisis. Higher the value, the more volatility the market, with a bearish outlook. If you look into the graph, VIX was at the highest during the subprime crisis. Presently, low value implies a bullish sentiment in the market… 

 CBOE VIX index in US is based on implied volatilities of S&P 500 index options. Volatility here is calculated as means of average standard deviation of underlying asset, it could be stock, index, currencies etc. According to Investopedia,” VIX is a computed index, much like the S&P 500 itself, although it is not derived based on stock prices. Instead, it uses the price of options on the S&P 500, and then estimates how volatile those options will be between the current date and the option’s expiration date. The CBOE combines the price of multiple options and derives an aggregate value of volatility, which the index tracks.” Implied Volatility in simple terms in the futurist probability of option price i..e call or put of an underlying asset. Implied volatility is one of the six measures you use to price the option using Black Scholes Model. Please refer to tutorials section here to understand derivatives etc.  

Coming back to S&P 500, which is the best gauge of US stock market, is undergoing one of the longest bull markets in US history. Unemployment which was at 10% during the crisis is today around 4.4%. Tech stocks have played a major role in the US rally. Source: Google Finance

FANG i.e. Facebook, Amazon, Netflix and Google (Alphabet)   are some of the best performing stocks this year in-spite of the recent tech crash. The market capitalization of Apple, Alphabet, Amazon and Facebook is $2.3 tr. (As of yesterday). According to an article published in WSJ, it is estimated that $100 bn of money would come to technology this year in the form of R&D by the above mentioned companies alone. But at the same time none of the companies are cheap on Price / Earnings multiple although they are not close to the astronomical valuation seen during the heydays of dotcom crisis. Corporate profit margins are at record high and investor sentiments very bullish…Looking at PE ratio of S&P 50

0, it trades at PE 25.73 compared to average PE ratio of 15.66. PE depends on future earnings and profitability of companies and this surge in PE is driven by technology companies which have the potential to deliver future discounted cash flows in the range of present PE multiples. Pic Source: http://www.multpl.com/

Its not expensive compared to its ratio during subprime crisis and tech bubble. Below fig. Market Capitalization as of 17-06-2017

Stock  Market Cap ( Bn)
Apple 727
Alphabet 650.27
Amazon 477.54
Facebook 437.71

Amazon which celebrated its 20 anniversary this year with closing price of $987. Listed at $18 in IPO, the stock went through 3 stock splits over the last three years. $100 invested during IPO would fetch $65,698 today. If you had invested $200 in Amazon stock during IPO, it would buy a two year MBA degree in an Ivy League school considering you are not able to get any aid. Amazon which at one time was struggling to make a profit has emerged not only one of the most innovative companies which refined eCommerce but also with Echo backed by voice assistant Alexa a front-runner in artificial intelligence. Echo has sold about $1b of Echo devices worldwide till now, stealing the march from Apple which had innovated the market for virtual based assistant with Siri and Google with Google Assistant. Jeff Besos, founder of Amazon, succeed because of his vision to focus on concentric or unrelated business like revival of Washington Post, focusing on streamlining state of art supply chain management through focus on logistics like purchase of fleet of trucks etc. Amazon had to innovate constantly by slowly sharing the  consumer habits of customers like encouraging digitization of books with a killer app like Kindle, introducing best in line customer relationship management, discounts and accelerated delivery through Amazon Prime. Innovation in artificial intelligence has helped in many other ways unimaginable. According to an article published by Time Magazine, Alexa recording to be first time produced in court for crime hearing to bring in evidence for a murder trail. Some might argue on the ethics of the case but ultimately the purpose is holistic and very judicious.

Visionary Nish ” Innovation begets Innovation…Creativity begets creativity” 

Lets look at the above quote. Jeff Besos, had a vision to  transform the eCommerce industry but he did not envision the sub innovations on the way. Success of Spotify and Netflix opened the market for online music and movies enabling Amazon to capitalize on its existing business and customers to start Amazon Music and Movies. Paypal changed the way we do business over net. Amazon model helped Alibaba and Flipkart to successfully replicate core model effectively in China and India respectively. Google transformed the world holistically by mapping the world and giving the killer app free with android phones. Android today is the most successful operating system used by all smart phones except Apple. This remains one of the smartest moves in recent business history to collaborate in a very profitable high margin smart phone market dominated by Apple at one point of time. The genesis of the idea comes from Bill Gates, who legendary vision not to sell MS Dos to IBM but to roll out as a royalty in computers led to proliferation of the operating system and defined an era of jump in innovation. Larry Page and Sergy Brin, Google founders refined the way we conduct search online through free based search toppling Alta Vista as the quintessential search engine. Larry bet on driver-less car something APPLE and Uber are also striving to succeed. Facebook’s foray into virtual reality and many other sectors formed the way to futuristic way of life. All is a puny in terms of wave of philanthropy generated by entrepreneurs in United States.Bill Gates defined an era of social impact and international development with Pierre Omidyar, Larry, Mark contributing immensely. Sergy Brin’s largess e in life sciences helped define an era of holistic innovation in medical care. One innovation lead to another innovation through a mutual collaboration leading to concentric innovation. As the pie of the market increased, leading to perfect competition to make the market a buyers market encouraging prefect competition. It not only helped companies in US but around the world  especially China and India, two other major innovation centers. This helped US immensely during the recession years and its affect can also be seen through Micro-finance and financial inclusion in Africa. It helped increase productivity, consumption which would otherwise been negative.

US leads the world because it is the leading entrepreneurship oriented and innovative country on this planet. 

But…But…There is a catch…

US wage growth has been tepid. Article in Bloomberg Business week estimates that the average hourly earnings growth this year is just 2.3% compared to 4% the last time the jobless rate was this low.

Charming Alexander Hamilton “A national debt, if it is not excessive, will be to us a national blessing.” First Treasury Secretary and Founding Father United States of America. 

Janet Yellen did the right thing in increasing FED rate despite low inflation because $4.5 tr of bonds purchases did not help much in generating corporate lending and injecting supply side inflation over the last decade.Source: FRED

It did however, help US in recovering from the second  worst stock market crisis in US history. Increasing FED rate is very important to avoid another crisis in asset markets. Over the last decade real wage growth has been constant for Americans i.e. wage growth adjusted for inflation, while retail price of goods has increased much more.

Why did this happen ?…To be continued…