The End of LIBOR

It has been announced that the UK Financial Conduct Authority (FCA) will be phasing out the main interest rate indicator, the London Interbank Offered Rate (LIBOR), by the end of 2021. This decision was reached as the FCA deemed the indicator has become unreliable. The LIBOR is a 50 year old global borrowing benchmark based on a daily price. This price is set at 11.45am GMT by averaging submissions from a group of 20 banks of a rate that they believe they could borrow money from other banks at. This rate is then used as a standard for pricing loans, mortgages, and other financial transactions and spans five different currencies.

This is not the first time that LIBOR has made headlines, having been the subject of controversy in the past when it came to light that banks had been submitting false data in 2012. As a result several of the big banks involved in the scheme were fined around $9 billion and several bankers were convicted for manipulating the projected rates.

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The decision to replace LIBOR within the next four years is predicated upon the fact that the underlying market of bank borrowing that LIBOR measures is not active enough to be a reliable measure. For one currency in one lending period in 2016 there were only 15 transactions. Andrew Bailey, widely predicted to be the Bank of England’s next governor, questioned “if an active market does not exist, how can even the best run benchmark measure it?”. As of yet no alternative has been announced, however, two measures have been suggested as potential replacements. Bailey has recommended the UK’s Sterling Overnight Index Average (SONIA) and a broad Treasury repo rate, which will reflect the cost of borrowing money secured against US government debt, as two viable benchmarks, both being strongly based in significantly active markets.

Despite the proposal of suitable alternatives there are some that believe that this transition will not be completed in the next four years with $350 trillion still in outstanding derivatives, mortgages, and loans to move to a new system. Mark Cabana, a strategist with the Bank of America Merrill Lynch, says that many banks may continue to contribute to the LIBOR rate after 2021. By this point it will no longer be necessary for banks to contribute calculations for rates in sterling, however, the LIBOR administrator, the US’s Intercontinental Exchange, may still publish the dollar rate.

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Despite the disagreement over deadlines it is certain that LIBOR, following corruption and growing irrelevance, is on its way out, to be replaced by more accurate and relevant rating systems.

The Impact of a Global Shift to Renewable Energy

As fossil fuel reserves are depleted companies have been looking for alternative sources of energy. However, does this mean that renewable energy companies are performing better than suppliers of traditional energy sources? At the end of 2016 over 24% of global electricity was produced from renewable sources, with hydropower being the leading source. Wind power accounted for 4% of this and 1.5% was from solar energy. These numbers, however, were still heavily overshadowed by energy from fossil fuels.

Hydroelectricity, which is the current frontrunner in the renewable energy sector, seems to be holding stable within its position. Brookfield Renewable Partners, which owns 215 hydroelectric facilities across North America, Latin America, and Europe, finished 2016 with revenue of $2.45 billion, a massive increase on the 2015 revenue of $1.63 billion.

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Increased interest in solar energy had seen huge advancements in the field, with solar power becoming increasingly cheap to generate. However, this in turn has meant that over the past year, solar stocks have experienced large declines in value, with some of the top companies being down by 50%. This slump may be caused by decrease in demand for solar panels in China, as well as a glut of panels, forcing prices down. Despite the current downward trend the outlook for solar energy companies is still positive, as the cost of generating power from the sun appears to be lower than the cost of generating it from fossil fuels. As more people are turning to this alternative energy source 2016 saw solar energy make up nearly 40% of all new energy installations, and companies seem to be recovering lost ground. First Solar Inc. saw first quarter revenue of $891 million, far beyond the $691 million consensus estimate.

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Companies working in wind power could also be set for increases in stock value. In the last year wind energy made up only 5% of total energy produced, but the American Wind Energy Association estimates that in the next ten years this figure could rise to 20%. As of the 10th of July the company Vestas Wind Systems A/S saw its stocks trading at $31.63, an increase of around 44% over the last 12 months. General Electric is also making a name for itself as a worldwide leader in the wind power sector, with the announcement of a planned acquisition of LM Wind Power for $1.7 billion.

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While some renewable energy companies are experiencing lulls in their revenue, it may be short-lived as, according to the Energy Information Administration, the costs of generating power from renewable sources is much less that the cost of power production from traditional sources. In the current economic climate it only costs around 1.3 cents per kilowatt hour to generate power from hydroelectric systems, and about 2.6 cents per kilowatt hour to produce electricity with nuclear power. As various companies work to create solar panels at a lower cost, solar energy could see a similar fall in cost to produce energy.

(Please note: James O’Leary does not currently hold a position in First Solar Inc., LM Wind Power, or Brookefield Renewable Partners. Henry James International does not currently own a position in First Solar Inc., LM Wind Power, or Brookefield Renewable Partners for any client portfolios).

(Please note: James O’Leary currently holds a position in General Electric and in Vestas Wind Systems A/S . Henry James International currently owns a position in General Electric, and in Vestas Wind Systems A/S in client portfolios).

China’s Gray Rhino Financial Risks

In the financial sector black swan events are those which are unlikely to happen but, if they did, would have a huge impact on the country and they are nearly impossible to predict. The elephant in the room is an event that everyone is aware of but no one wants to address. A new animal has recently been added to the list of financial risks – the gray rhino. A gray rhino risk is an event that is highly probable and high-impact that officials have neglected to address. China is currently facing just such a risk as debt has built up in Chinese banks and firms due to the unregulated shadow banking system.

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China’s economic growth is founded on a system of credit and the growing debt levels have surged China’s non-financial debt-to-GDP ratio to over 250%. Having neglected to curb bank borrowing previously, President Xi has now begun efforts to prevent a financial crisis which could negatively effect the domestic economy and result in social unrest. However, the current situation presents somewhat of a catch 22. Tackling debt levels would result in a sharp drop in growth, meaning a large portion of the population could find themselves without employment. If left as it is with no attempts to solve the issues, the financial situation could lead to the banking system crashing.

As the government begins to address this long-standing issue, investors are worrying that risky assets, such as small stocks, may bear the brunt of the damage, as many of them are purchased using credit. The Shenzhen, China’s small-cap index, fell by 4.3% on the 17th July while the tech-focussed ChiNext index closed the day at 5.1%, its lowest point since 2015. The government’s expansion of regulation into more aspects of the economy, rather than just financial sector excesses as before, has prompted many investors to sell off their domestic stocks. If Chinese stocks suffer as a result of efforts to rectify the gray rhino risk, the effects could be felt in other countries. In a global market, if a country as influential as China experiences problems other areas will follow.

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Despite the issue of bank debt finally being addressed by the Chinese government, the country’s growth in the second quarter of 2017 was still 6.9%, a faster rate of growth than predicted. While this puts China back on track to meet its growth target this year, it means that the country is still heavily relying on debt-fuelled investments to develop GDP. To target the gray rhino risks, China should address problems that could arise from liquidity, shadow banking, credit, and avoid falling victim to price bubbles in the insurance and property markets. The outcome otherwise could be negative for China’s economy.

Decline of the Silver Screen Industry?

How consumers choose to view movies has been changing over the past few years with a move towards home viewing using companies such as Netflix and Amazon Prime. This viewing trend is beginning to take its toll on both film and television studios, as theatres are becoming a less popular option for viewings. Currently Americans spend around $11 billion on going to movie theatres every year and a further $12 billion on home video rental and purchase (both physical and digital). Home purchase, however, was down by 7% in 2016, compared with the previous year, while subscription streaming leapt up by 23% in the same time period to $6.23 billion.

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Film companies are beginning to tap into the financial benefits they could reap from employing more watch on demand options when it comes to new films. Premium video on demand (VOD) has the potential to be two to three times more valuable to studios that movie ticket sales, and, as a result, some Hollywood studios are looking into the benefits of in-home releases of new movies. These early-release films would be available to see at the same time as, or shortly after, theatre release and would cost home viewers around $30 to $50 in comparison to the $5 to $7 currently paid to view movies months after the release day.

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While this shift in focus to subscription streaming could benefit, and boost revenue, of Hollywood movie studios, the impact could be negative for movie theatre companies. In the past two months Imax China has seen share prices fall dramatically. Nomura analyst Richard Huang has said that four reasons were put forward for this drop, one being wide-spread concern that there is a drop in consumer interest for premium movie viewing experiences and that, as a result, Imax will begin to face structural market share loss. This, and the other three reasons – concern over dwindling popularity of Hollywood blockbusters, a belief by some that Imax is choosing the wrong movies to screen, and the suggestion that the majority of new Imax screens have been installed in lower-tier cities – has resulted in Imax stock values falling by 40%.

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As the movie industry moves into this state of transition, several companies within the sector have seen drops in stock price. Opening on the 5th of July Walt Disney shares were down 1.4% to $105.98, while Lions Gate Entertainment experienced a drop of 1.3% to $27.77, and Regal Entertainment Group declined to $20.07, down 1.5%. It remains to be seen if this downward trend will continue for movie companies or if the proposed, alternative audience viewing options will reverse the losses.

(Please note: James O’Leary does not currently hold a position in Netflix, Amazon Prime, Imax China, Walt Disney, Lions Gate Entertainment, or Regal Entertainment Group. Henry James International does not currently own a position in Netflix, Amazon Prime, Imax China, Walt Disney, Lions Gate Entertainment, or Regal Entertainment Group, for any client portfolios).

The Robotics Revolution

As research in the robotics sector continues to advance so does investment interest in it, as well as the switch from human contribution within a variety of sectors to the use of robots within the same roles. This has seen many companies benefit from the new technologies, through streamlining of processes with automation.

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In a recent deal Google has sold its advanced engineering and robotics unit, Boston Dynamics, to Japanese multinational company Softbank. The acquisition, which is believed to have been for around $100 million is just one of many recent acquisitions by Softbank, as part of its $100 billion tech investment “Vision Fund”. They have also recently taken over British chip designer, ARM Holdings for $32 billion, and office space start up WeWork for £300 million.

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Following the introduction of their dual-arm collective robot in 2015, Swiss industrial company ABB has experienced significant growth in interest, with their American depository receipts having gained 11% since March 2017. In fact, many robotic stocks have remained attractive to long-term investors, with German robotics company Kuka up 9% and Rockwell Automation, an American industrial automation company, up 7% since March 2017. The fear with the rapid growth of this industry is that many people may lost their jobs as companies choose to automate more and more of their processes. However, Jeff Immelt, CEO of General Electric, believes that, at least in the first part of the revolution, robots will actually help to make existing workers more efficient in their roles, rather than replacing them.

While this may be the case in some companies, in others the threat of replacement by robots is more immediate. Following Amazon’s $13.7 million deal to acquire Whole Foods, founder and CEO Jeff Bezos plans to automate the warehouses of both companies with a new fleet of robots, aimed at streamlining the distribution process. This could potentially put thousands of employees out of work in America, as well as in Canada and the UK. However, currently, Amazon’s hiring rates have not been affected, with employee numbers up 43% on last year, with 351,000 employees at the end of March, and the full effect of bringing in new robots awaits to be seen.

Asimo at the Robots exhibition © The Board of Trustees of the Science Museum

The future of manual work within big industries remains uncertain, however, interest in the robotics industry seems set to continue growing. As new products are continuously developed their uses within various sectors will continue to expand.

(Please note: James O’Leary does not currently hold a position in Kuka, Rockwell Automation, Amazon, Whole Foods or Google. Henry James International does not currently own a position in Kuka, Rockwell Automation, Amazon, Whole Foods or Google, for any client portfolios).

(Please note: James O’Leary does currently hold a position in ABB, General Electric, Boston Dynamics, or Softbank. Henry James International does currently own a position in ABB, General Electric, Boston Dynamics, or Softbank for any client portfolios).

Market Overview – Australia’s Recent Finance and Retail Activity

Recent financial developments in Australia have signalled overall positive growth in several sectors, including areas of technology and finance, while in the retail sector recent announcements may have negative impacts on national businesses in the short term.

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A recent dip in interest rates has eased up mortgage stress, with the number of mortgage holders in Australia considered “at risk”, dropping by 1.6% in the last year, from 744,000 to 660,000, making up 16.8% of all mortgage holders compared to the previous 18.4%. While this is a move in the right direction, those with lower incomes are still at a higher mortgage risk. Of mortgage holders with a household income over $100,000 per annum only 1% were considered to be “at risk” while this jumped to 85.3% of mortgage holders with an income of under $60,000. If interest rates continue in this downward trend fewer mortgage holders may be considered “at risk” however, an appreciation in interest rates will abruptly have the opposite affect.

The Australian state of Victoria is experiencing changes in another area of the financial sector with the release of development plans by the Victorian government, announcing the establishment of a fintech center in Melbourne. According to the Victorian Premier Daniel Andrews the hope is that this will not only strengthen the Australian fintech sector by bringing together start-up companies with investors, researchers, and industry corporates in one work space, but that it will also create new jobs in the area. Technology is fast changing the way the financial sector works and the plans for this fintech hub will provide Victoria with the opportunity to win a bigger share of the industry.

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While developments with in the financial technology sector are positive, Amazon’s announcement of their $13.7 million bid for the grocery company Whole Foods has had a drastic effect on Australia’s retail sector. Supermarket company Woolworths experienced a drop in value of 3% while Metcash fell 1.7% and Wesfarmers, the operators of the supermarket chain Coles, dropped by 1% following the announcement. Companies in the electronic appliance field have also noticed depreciations as Amazon announced their bid to expand into the grocery sector. JB Hi-Fi is down 18% this year while Harvey Norman dropped 25%, and its stocks are down by 2%. Alongside the acquisition of Whole Foods, these drops are fuelled by Amazon’s intention to expand across Australia this year. Many analysts believe that this will have further negative effects on Australian companies, as Amazon eats into their earnings.

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(Please note: James O’Leary does not currently hold a position in Amazon, Whole Foods, Woolworths, Metcash, Wesfarmers, Coles, JB Hi-FI, or Harvey Norman. Henry James International does not currently own a position in Amazon, Whole Foods, Woolworths, Metcash, Wesfarmers, Coles, JB Hi-FI, or Harvey Norman. for any client portfolios).

Post-Election Economic Activity

The results of the UK general election on June 8th have left many factors in a state of uncertainty in Britain. The country has been left with a hung parliament, with the Conservatives only securing 318 seats of the 326 they needed to win a majority. This political result has had effects, both positive and negative, on areas of the economy and investment markets.

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Previous trends have shown that, when there is anticipated disturbance in the political sector, investments in commodities such as gold increase as people try to hedge their bets against economic losses. In the run up to the election, there was increase of 64% in people investing in gold for the first time, while numbers of financial professionals buying physical gold were up 49% in the week leading up to the vote.

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Following the announcement of a narrow Conservative win the sterling experienced a sudden drop of 2% in value against the dollar to $1.2683, its lowest level in two months though it regained a little ground back up to $1.27 on Friday the 9th. It is predicted that sterling will continue to experience some level of volatility in the short term.

While the election results have hit some areas of the economy negatively, others are thriving after the news. The FTSE 100 ended on the 8th of June up 1%, while the Stoxx Europe 600 experienced an increase of 0.3%. Global businesses, such as Diageo, Reckitt Benkiser, and Unilever also observed upward movement, all trading at around 1.5% higher by the 9th. Increased value of shares of exporting companies, which make up three quarters of the FTSE 100, are expected to do better as the weakened currency is likely to rise income earned abroad.

The narrowness of the Conservative win will have an impact on how the upcoming Brexit negotiations are carried out as well. Theresa May gambled the Conservative status as the ruling party in the hope of gaining an even stronger position in the negotiations however, this has backfired with no party having an overall majority in the UK parliament. The weakened Conservative position means that a more lenient Brexit deal may be agreed on as opposed to the “hard” Brexit that May hoped for, with no trade deal.

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As the Conservative party enters into discussions with the Democratic Unionist Party (DUP) about a possible coalition, economic uncertainty may continue. This coalition would see the DUP adding their 10 parliamentary seats to the Conservative seats, giving the party the majority it needs to pass legislation, and gain a stronger hold over the Brexit negotiations.

The Rise and Fall of the Metal Market

Many investors look at gold as a safe bet, an insurance policy for times when other stocks are less certain. In this year an ounce of gold has increased in value by almost 13%, to $1,296. There are two schools of thought about why the commodity has experienced such a high level of growth after having been uneasy in the first part of this year. The first is that this increase comes off the back of political unrest. As political tensions grow both in the US, with continuing problems among the Trump administration, and in the UK, with the recent attacks as well as the general election, some believe that these could begin to affect the economy, and upend corporate profit growth. Gold is a stable way for investors to hedge their bets against this possibility.

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Another idea is that, rather than gold prices being increased as a result of politics, the rise could be linked more to the state of the economy and monetary policy. The US dollar is currently near a seven-month low compared to other world currencies and it has been observed on several past occasions that as the dollar falters the price of gold rises. Others believe that recent rise and fall in gold price is seasonal, with Frank Holmes, CEO and Chief Investment Officer of US Global Investors saying that there is a 60-70 % chance that the price of gold will experience a general upward trend between June 2017 and January of next year.

While gold may be a safe bet in its current state there are also other metal commodities worth following. As the demand for electric vehicles continues to grow, so will the demand for both lithium for batteries and copper for wiring, making these possible safe and lucrative investment options.

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The auto industry is also responsible for an upward trend in the price of palladium, a crucial component of catalytic converters. After having sunk to $657.50 per ounce in December 2016 the precious metal has risen by 24% in 2017 to a current price of $856.60. However, while it has regained its ground having been near a seven-year low since January, there are concerns that palladium may not be able to maintain this as there is a slowing in car sales in the US, Europe, and China. In the US car sales fell again in May, contributing to a consecutive five month decline, while in the EU, although sales rose by 4.7% in the first four months of 2017, they then dropped by 6.6% in April. Other countries have, however, experienced continued growth in auto sales, such as Canada whose sales increased by 11% in May. The result is divided opinion on the future of palladium, with some believing that it has reached its peak and others of the opinion that it will hold its ground and possibly even continue to appreciate in price.

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The Rise of Artificial Intelligence

Manifestations of artificial intelligence (AI) stretch back as far as Greek mythology however, it has only taken off in a huge way in recent years. As interest in this field grows more, big-name companies, such as Google, Yahoo, Apple, Intel, and IBM are competing to acquire private AI technology development companies, with nearly 140 companies having been acquired already. Market research firm Tractica has predicted that spending on AI will grow from $640 million in 2016 to $37 billion by 2025.

A front runner in the development of AI has been the UK, where London-based venture capital company Octopus Ventures first invested in the natural knowledge answer engine Evi (now the technology behind Amazon’s Echo) in 2008. The firm continues to be an active investor in AI, selling products, such as the app Swiftkey, to high profile companies like Microsoft. Octopus Venture’s Investment Director, Luke Hakes, believes that their AI successes are why the UK is now the inspiration for other countries in how AI can be commercialised, and this growing interest will have the effect of more funding being put into AI companies.

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As well as seeing the AI market itself grow exponentially, other companies are experiencing growth off the back of AI’s success. Companies who develop and make chip technology have seen a revival as the demand for new AI products had prompted the need for chips tuned to carry out very specific functions, and with the ability to store and synthesise information in novel ways. Companies such as Advanced Micro Devices, Intel, and Nvidia have all benefited from this growth, with Nvidia’s latest quarterly results stating that it has nearly tripled sales of chips to data centers involved in AI. 21% of the company’s revenue is now from computing tasks that include AI, amounting to $409 million for the last quarter.

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Growth in this sector is being spurred on as well-established companies implement AI technologies to enhance their user experience. Facebook has developed its own AI program, DeepText, that analyses posts to understand the context of them, recognises faces in photos to make it quicker to tag people, and is even able to identify people and their voices in video content. Outside of the online sector, much research is being carried out into the use of AI in the transport field. By 2035 around 76 million vehicles with some level of autonomy will be in use, comprising a market that will be worth $77 billion.

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Although much of the development into these technologies is relatively new, investment in AI seems to be strong and stable, with a predicted steady increase in the future.

(Please note: James O’Leary does not currently hold a position in Google, Twitter, Intel, IBM, Advanced Micro Devices or Nvidia. Henry James International does not currently own a position in Google, Twitter, Intel, IBM, Advanced Micro Devices or Nvidia for any client portfolios. James O’Leary does currently hold a position in Apple. Henry James International does currently own a position in Apple).

pixaAll content in this blog represents the opinion of James O’Leary

Surge of the Social Media Sector

With the rise of a generation that spends a large portion on its time online, it is no wonder that many social media companies are experiencing significant growth. Furthermore, that the status of longer-established platforms are being threatened as new platforms are developed.

Following a multi-year fall, Twitter shares are up 26% in the last month. This unexpected growth has been accredited to deals that Twitter has made with media companies to stream video content from the Twitter app. These deals include the rights to stream various National Football League (NFL) content, though not the 10 Thursday Night NFL games it had the rights to last year, and which it missed out on this year to Amazon. As these deals come into play it awaits to be seen if Twitter can maintain this recent growth or if it will return to the recent pattern of decline.

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The long-standing social media platform, Facebook, has managed to maintain its high-ranking position, even as other social medias are developed that could rival it. The network, which has 1.86 billion monthly users, and also owns big-name platforms Instagram and WhatsApp, has seen its stocks grow by 25% over the past 12 months. Although Facebook has seen a slight slowing down in advertising recently, it still holds the position as the second largest display ad company in the world, after Alphabet’s Google. Analysts estimate yearly growth of 37% and 28% in revenue and earnings respectively as the company introduces new advertising products, increases its use of video advertising and increases user numbers.

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Another platform which can attribute its recent growth, in part, to advertising revenue and the development of new video hosting technologies is the Chinese social network Weibo. With annual growth of 43% annually to $212 million last quarter and monthly active users (MAU) increasing by 33% to 313 million the microblogging network is growing rapidly. Wall Street analysts predict that this year Weibo will see a revenue increase of 51% and that its non-GAAP earnings with rise by 62%.

A proliferation of dating sites have sprung up in recent year and platforms such as Tinder, Match.com, OKCupid, and PlentyOfFish are all under the umbrella of Match Group. In the last quarter this company saw 92% of its revenue come from Match.com and Tinder, which now has over 50 million users. While often these platforms are free, Match Group has managed to increase revenue by creating premium options, where users can pay for extra features. Last quarter paid member count rose to 5.7 million network-wide, an annual increase of 23%. This boosted total revenue by 20% and increased earnings by 21%.

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While the outlook of these companies is overall positive in the short term, maintained growth is not a sure thing. As competition in the social media sector increases companies will have to continue to develop and innovate in order to stay relevant and experience positive growth.

(Please note: James O’Leary does not currently hold a position in Twitter or Match Group. Henry James International does not currently own a position in Twitter or Match Group for any client portfolios. James O’Leary does currently hold a position in Facebook and Weibo. Henry James International does not currently own a position in Facebook and Weibo).).

All content in this blog represents the opinion of James O’Leary