“When a measure becomes a target, it ceases to be a good measure.”


This week’s EVA is our once-a-month sharing of commentaries from our partners at Gavekal Research. As you will see, this is a “two-fer”: the first written by Gavekal’s founder, Louis Gave, while the second was penned (or keyboarded) by his father, Charles Gave.

Louis’ article, “Peak Hubris”, highlights the escalating confrontation between Big Tech and Big Government. As he points out, some of the world’s largest technology companies are in a position where they can actually influence public attitudes, viewpoints, and possibly even elections.

Unsurprisingly, this makes certain governments—maybe even most—increasingly edgy. In fact, the Wall Street Journal ran a front page article on precisely this subject just two days ago. It described allegations that the “news curators” at Facebook have been suppressing conservative views and elevating those (presumably more liberal) that weren’t popular “trending topics”. (Is it just me or does the term “news curator” give you a creepy Orwellian feeling, as well?)

Similarly, Apple’s refusal to unlock its iPhone for US law enforcement officials has possibly raised eyebrows in Beijing, causing Chinese authorities to “encourage” the sale of domestic smart-phone producers such as Xiaomi or HTC. (Note: the “Occam’s Razor” Louis refers to is the logic rule stating that the simplest hypotheses or explanation is typically the best choice.)

Charles’ piece is on a topic that is near and dear to Evergreen’s philosophical heart: the dangers of passive investing becoming the dominant force in the financial markets. Several past EVAs have pointed out the risks and distortions caused when a benchmark becomes an investment strategy. As we noted years ago, when passive or index-investing was a niche vehicle, it didn’t have much impact on financial markets. Now with trillions either directly or indirectly tracking various benchmarks (most notably the S&P 500), undesirable effects are becoming more significant and frequent.

For example, professional investors seeking to replicate the S&P are forced to hold more of the largest components of that index regardless of valuations. Clearly, this reality amplifies both up- and down-moves, meaning that overpriced areas tend to become more inflated than they would in the past when almost all assets were run by managers who did fundamental analysis. In a similar way, passive investors wind up with less exposure to inexpensive and out-of-favor securities than they would with less of an autopilot-type influence. One could argue this is a key reason why bubbles and busts have become more common over the past 15 years.

The net effect is compromised financial markets that produce a lower rate of return than in “the good old days”. Certainly, the fact that the S&P 500 has returned just 4.3% for the last 16-plus years indicates some validity to that contention. And, as we have noted in prior EVAs, just wait until this calculation is run during the next bear market. When it is, you won’t be hearing about stocks for the long-run—even though that will be precisely the time you should be.
Chief Investment Officer
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*The specific securities identified and described do not represent all of the securities purchased, held, or sold for advisory clients, and you should not assume that investments in the securities were or will be profitable.  Facebook and Apple are used only to explain recent well publicized events regarding these companies, and these events possible effect on the market in general.  HTC and Xiaomi are used only for illustrative purposes.  ECM currently holds Apple and may recommend it for client accounts if ECM believes it is suitable investments for the clients, considering various factors such as investment objective and risk tolerance.  It may not be suitable for all investors.  Certain clients may hold Facebook, HTC and Xiaomi in their accounts, at their discretion; these securities are not recommendations of Evergreen. Please see important disclosures included following this letter.



By Louis Gave

With a few notable exceptions, it’s been a tough few weeks for technology firms; the likes of Microsoft, Intel, Alphabet, TSMC, Sony, Panasonic, Fanuc, Murata and, of course, Apple all released weak earnings and guidance. Behind the disappointments sit different causes, ranging from weak capital spending across Asia (Fanuc), to a less eager Chinese consumer (Apple), to a still prudent Japanese consumer (Sony) and a stronger yen (Murata, Panasonic). Apple is the most interesting case, for not only has it been the last decade’s blow-out success story, but only last summer Chief Executive Tim Cook told CNBC that its China business was growing gangbusters. A few months later it turns out that Apple’s sales are down YoY for the first time since 2003, mostly because of a -26% fall in Chinese iPhone sales. Since overall smartphone sales in China grew 2.5% YoY, the iPhone’s weakness is a head-scratcher. Perhaps it is just a case of theiPhone no longer being this year’s must-have item. Or maybe Apple is simply too pricey compared to the likes of HTC, Xiaomi and Samsung. On the face of it, the latter explanation seems the most likely.**

Interestingly, Apple’s stumbles have occurred just as a number of major tech firms are developing what might be dubbed “peak hubris”. The likes of Facebook, Alphabet, Apple and Amazon increasingly enjoy monopolistic-like franchises: an Apple IOS user is unlikely to switch to Windows once all of his or her music, photos and movies are on the Apple platform. Similarly, a company which relies on Google advertising for website traffic is unlikely to change provider. Indeed, looking at these tech firms’ dominant positions, it is hard to escape the conclusion that they should be able to lock in a sustainable rent that will only be taken away by a) a genuine technological leap or b) a full-frontal government attack (similar to Teddy Roosevelt’s anti-trust activity).**

Such an underlying reality begs the question of why such behemoths have seemingly gone out of their way in recent months to wind up governments. From Alphabet’s aggressive tax optimization strategies, to Apple’s refusal to unlock the San Bernardino terrorist’s phone, to Amazon’s aggressive pursuit of drone delivery strategies, it seems that the tech titans are telling governments—the only distributor of legal violence in the system—that they are strong, and do not need to kowtow.

And this may be true. After all, through their control of news-flow, the influence of “Big Tech” now exceeds that ever achieved by the newspaper barons. So perhaps Big Tech is right to stand up to governments and has nothing to fear. Or perhaps the coming years will show that, instead of being smart, Big Tech was simply being hubristic; that paying a higher tax rate (and maintaining a monopolistic situation) would have been smarter than facing anti-trust lawsuits. That complying (quietly) with a (perhaps legally dubious) order from the Federal Bureau of Investigation might have made more sense than creating bad blood and a desire for payback within the federal law enforcement community.

At stake is the question of whether governments everywhere remain jealous of their power, and will take down corporates which are perceived to stand in the way (as they have in the past), or whether we are entering into a new era where Big Tech, given its global reach, turns

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