Market

The curse of less bigness

Good morning. I couldn’t think about bonds any more so I tried to get down some thoughts about a what a government push to increase market competition might mean for markets. A very slippery area, where I’d be keen to hear your arguments: email them to me at Robert.Armstrong.

Is competition bad for stocks?

Charles Wilson, chief executive of General Motors (and, later, Secretary of Defense under Eisenhower) never said that “what is good for General Motors is good for the country” — a line widely attributed to him. But he came very close. During his confirmation hearings for the Pentagon job in 1953, a senator asked Wilson if, given the $2.5m in GM stock he held, he could make a decision that would help America but hurt GM. Wilson said: 

I cannot conceive of one, because for years I thought what was good for our country was good for General Motors and vice versa. The difference did not exist. Our company is too big. It goes with the welfare of the country.

He ended up selling the shares to secure the job, but he was not too fussed about being misquoted. “I have never been too embarrassed over the thing, stated either way,” he said some years later. 

Anyone who has spent time with the people who run “too big” companies knows that Wilson’s inability to imagine any separation between the interests of company and country persists today.

The Biden White House does not share this view. From last week’s executive order on competition:

Over the last several decades, as industries have consolidated, competition has weakened in too many markets, denying Americans the benefits of an open economy and widening racial, income, and wealth inequality. Federal government inaction has contributed to these problems, with workers, farmers, small businesses and consumers paying the price.

For investors, the administration’s renewed focus on encouraging competition, through rulemaking and antitrust enforcement, raises three questions:

  1. Is the American economy really less competitive than it once was?

  2. Does diminished competition mean the American economy performing below its potential — with “potential” measured in terms of broad-based, stable prosperity?

  3. If the government increases competition through regulation, might that reduce corporate profits and stock market returns? The same companies most often cited as potential monopolists — notably in big tech — have been among the best investments in recent decades.

I do not have a settled view on any of these, and as a market writer I am principally interested in the first two as they will help answer the third. But all three are big and important. What follows are some initial thoughts in what will become a periodic series.

The inequality is not in question

One thing we can say with certainty is that the distribution of value and profit among modern American companies is very unequal. A glance at the S&P 500 shows this. I ranked its members by market capitalisation, and then picked out the biggest company, and the top 5 and 10, as well as the five overall quintiles. Here is market cap (all data from S&P CapitalIQ):

This is dramatic. The top ten companies in the S&P have almost as much market value ($11.8tn) as numbers 101-500 combined. The top 100 have more than two-thirds of the index’s value.

Another way to look at the same point. The distribution of value in the S&P, 1 through 500, looks like this:

Net income for the index follows much the same pattern as market cap (as it must, given the strong link between profit and market value) but is even more extreme. Over the last four quarters, the top ten companies made just over a third of the index’s profits; the top 100, almost three-quarters.

The return on capital chart is impressive too. The top ten companies (Apple, Microsoft, Amazon, Alphabet, Facebook, Berkshire Hathaway, Tesla, Visa, Nvidia and JPMorgan Chase) are a clear step above the rest in profitability:

These snapshots tell us something about why American capitalism feels uncompetitive (and remember, these are 500 of the biggest public companies — these charts show how the truly massive dominate the merely huge). The very biggest companies capture a high proportion of the profit and value. But while this fact gives context, it does not answer our three questions. Is the concentration of value the result of lack of competition? Is it a bad thing for the economy, or a good one for investors? Keep these points in mind:

  • The most valuable companies are mostly in tech businesses that enjoy both powerful operating leverage and network effects/first mover advantages. Whether or not they abuse those advantages, they were always going to be very profitable companies, under most any non-confiscatory regulatory regime. (This is a contentious point and hard to prove, but I think it makes sense. Send me a counterargument.)

  • Value under capitalism may simply have a very abnormal distribution — with the big winners worth multiples of everyone else — and that fact may not mean the economy is working sub-optimally. A few novels sell millions. Most sell in the thousands if at all. This has been true forever. Is the literary market uncompetitive?

  • None of these charts capture the direction of change. Is the distribution getting more lopsided over time, and has that helped or hurt the economy? Figuring this out from company data is tricky, but I’m working on it.

Intuitive, but not obvious

Back to the first of the three questions: is the US economy less competitive?

One intellectual standard-bearer for the anti-oligarchy movement in the US (and elsewhere) is the French economist Thomas Philippon. He makes the empirical point that many US industries are more concentrated than they once were, and argues that corporate investment (and therefore productivity) are lower as a result. Here are the two charts from one of his key papers on the topic. First is industry concentration, as measured by average Herfindahl-Hirschman Index (the sum of the squares of companies’ market shares) across sectors:

And here is US corporate investment, both actual and compared to what one might have expected given the valuations of corporate assets (valuation here measured by Tobin’s Q, the ratio of companies’ market values against the replacement value of their assets, which is sort of like book value):

The link between the two is intuitive. Why should a company that is not feeling the competitive heat invest in innovation? But there is a step in between, linking concentration to competition. It is not obvious that fewer, bigger companies means a significantly less competitive economy. This is the trickiest bit of the debate and it is not settled. Andrew Smithers, the economist and sometime FT contributor, raises a straightforward factual objection. He points out that capital’s share of national output has not risen consistently in recent years, which makes it seem unlikely that competition is falling very much. Here is a chart from one of Smithers’ papers:

A small number of firms capture most of the value. Industry is more concentrated. It is intuitive that those two factors should add up to lack of competition (and productivity). But I am not yet certain that this intuition is correct.

Should investors care?

Oligopolists and monopolists almost surely suck profits out of smaller firms. But do they make the whole profit pie smaller? Over the long term, if oligopoly hurts productivity, companies as a whole should become less productive and therefore less valuable. But in the short term, would breaking up Amazon (for example) make it a less valuable company? Would stopping Google (for example) from buying up smaller rivals make it (or the smaller rivals, or the two combined) less valuable? More on these questions in days to come.

One good read

A nice column from my former colleague Spencer Jakab in the WSJ, on “The Tinkerbell Effect” — how investors’ hopes for meme stocks can make corporate executives’ dreams come true.

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