Investing in a Winner-Take-All World
The CFA Institute Fixed-Income Management Conference is an annual event focused on global debt markets, fixed-income sectors, security selection, and portfolio construction. The Fixed-Income Management 2019 Conference will bring together researchers, analysts, portfolio managers, and top strategists in Boston, Massachusetts, on 17–18 October.
This time is different for the giant companies leading the global economy.
That’s according to chief economist Erik Weisman, PhD, and research analyst Sean Cameron, CFA, of MFS Investment Management. At the CFA Institute Fixed Income-Management 2018 Conference, the two explained that economic activity has become more concentrated among fewer companies, and the dominant firms now dominate differently than they have in the past.
The result is a new kind of market supremacy that government regulators may leave undisturbed.
“The Federal Trade Commission and the Department of Justice, they don’t have the tools to figure these things out, and they wouldn’t know a monopoly if they actually saw one,” Weisman said. “And at least right now, they’re not looking very hard.”
Weisman noted that the number of US public corporations has declined dramatically, and earnings have become more concentrated among those firms. In 1975, 109 firms represented half of all earnings. In 2015, that number had fallen to 30 firms. “You can see this same kind of process taking place with assets and dividends, cash and sales. It’s pretty all-pervasive,” he said.
Cameron explained that people already see this with companies like Google and Facebook, but it’s happening everywhere. “You’re seeing concentration take place across the board, and in over three quarters of sectors and industries over the past 20 years, you’ve seen an increase in concentration,” he said.
“The difference in the mean and the median has become more pronounced in general, if you look at both earnings, wealth, the reach and scale of a star,” Cameron said. “And also at the firm level as well, we’re seeing dispersion and a ‘running away’ of the number one in the pack against everyone else.”
Today’s winners have scaled differently through evolving methods of organization that allow them to use their platforms in new ways. Weisman explained this with a brief review of the tension between central planning and distributed decision making in allocating resources.
Theory holds that distributed marketplaces can organize economies more efficiently than central planning. But firms still exist within markets, operating as centrally planned organizations, because some activities require top-down decision making.
“Platforms synthesize the two,” Weisman said. “A digital platform creates a market that you didn’t even know was missing — like Uber and Airbnb — and then it centralizes it by bringing producers and consumers together to connect.” These platform companies have a different way of establishing a monopoly that is more difficult for regulators to address directly, because there is little evidence that consumers are being harmed.
Broadly, these new monopolies paint a grim economic picture. Weisman explained that the winners in today’s markets are larger, older, and less dynamic than their competitors. “Small companies, we are told, and new companies, are the engines of growth,” he said. “Both in terms of GDP and in terms of labor demand.”
Small companies are the primary actors driving Clayton Christensen’s theory of disruptive innovation, but that idea may be less relevant in a world where start-ups are founded with a goal of being acquired by industry superstars. “They will not necessarily challenge the incumbents, so those incumbents become stodgy. And they become calcified,” Weisman said.
Meanwhile, the incumbents may not have the same effects on capital markets as their predecessors. Weisman called it “scaling without mass” because their enormous market capitalization was achieved with less capital and less labor. “Thus, the demand for capital is lower,” he said. “The demand for labor is lower. Wages, potentially, are lower. And it suggests lower growth. And perhaps lower inflation as well.”
In this environment, Cameron expects that security selection will take on a new emphasis in portfolio construction. “There’s an ecosystem in which you have an increasing wedge, or gulf, between the winners and the tail of everyone else that’s losing,” he said, “which makes the impetus on choosing the right names that much more important.”
“Yes, you’re going to have a right tail of outperformers,” he said. “And you want to own some of those names that you think are the superstar firms that will go from strength to strength. But it also implies that the punishment for being a loser company could manifest itself in a more painful way.”
The feedback loop of these dynamics suggests that they will persist for a while. But things will eventually change. “You can’t have this inexorable separation of a right tail from a left tail, or a bottom from a top, and assume that can just go on indefinitely,” Cameron said.
Three forces could derail the winner-take-all trend in markets, according to Weisman and Cameron: increasing antitrust concerns, privacy concerns, or populism.
“There’s a book called The Great Leveler, by Walter Scheidel, that touches on how inequality tends to end,” Cameron said. The book’s assertion is that inequality never dies peacefully.
“Whatever the corporate equivalent of violence will be,” he said, “could manifest itself.”
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image courtesy of Paul McCaffrey