Thursday, September 5, 2019

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The richest companies are getting richer

The four most demonized words in investing are "this time is different."

The reason why is simple — many investors hold that those who do not learn from and respect market history are doomed to repeat it. This argument is the basis for why some believe stock prices will have low returns from current valuation levels. Or why stocks could crash at anytime. It's happened before (once!) so it will happen again.

But U.S. market history only goes back 150 or so years. There have been just a handful of distinct market cycles. Each of these were different. And this time literally is different. It doesn't make you a fool to say this out loud.

In his latest investor letter published this week, GMO's head of asset allocation Ben Inker outlined what I think is an important but often overlooked part of how the current cycle is different — corporate inequality.

Corporate earnings as a percent of U.S. GDP have been elevated since 2004, even accounting for the ups and down profits seen during economic cycles. But Inker highlights that this elevated profitability has not been evenly distributed among corporations. Because just as the richest citizens have gotten richer in the last several decades, so too have the richest corporations gotten richer.

From 1986-1995, the 50 biggest companies were responsible for 15% of profit growth seen by the 3,000 largest companies in the stock market. From 2006-2019, that percentage increased to 24%. In both periods, companies 2,500 through 3,000 accounted for around 11% of increased profitability. The fortunes of smaller companies, in other words, have been flat while large companies have flourished.

Inker writes that this extended period of outperformance from large companies "suggests this effect is not something we should expect to correct over a single business cycle." Though he adds that, "my guess is that the world in the future will be less favorable to these large, dominant companies than is true of the current environment."

Growing scrutiny of large tech companies and the increasing support Medicare For All has gained are just part of how Inker sees the tide potentially turning against the market's profit hogs. It is why he argues that, "the wiser bet is to assume the world will not remain entirely safe for dominant companies."

But whether you agree with Inker's vision of the future doesn't really matter. What matters is that his work shows how this cycle is different. The fortunes of big and small companies have diverged markedly and the divergence has been sustained.