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‘This time is different’. We are well aware of the fact that these four words have been called the most dangerous words in investment by Sir John Templeton. Dangerous, as they have been used regularly to identify a paradigm shift that warranted higher stock prices just prior to the painful correction back to the not-so-different normal.
Still, these words seem to be the best way to characterize the remarkable shift that has been underway in the US corporate sector: fewer and fewer companies are producing an ever-increasing share of the total earnings pie. Back in 1975 it took the top 109 companies to produce 50% of all earnings, whereas in 2015, this was achieved by just 30, according to economists Kathleen Kahle & René Stulz. The winner may not take all, but it is getting closer and closer to the truth, it seems.
One popular notion is that this is a reflection of the new business model ushered in by the likes of Facebook, Airbnb and Amazon. For these platform-based companies, the size of the customer base has been a critical factor to their success. As the match between supply and demand is most effective on a platform with the biggest customer base, the winner-takes-all principle seems to be more prevalent among these web-based businesses than brick and mortar companies.
Additionally, these new companies have set up their businesses according to the spec of the modern world and are therefore not burdened by high overheads and legacy costs. As such, they can also be considered to be a disruption. Research also shows that concentration has been on the rise due to a continuous process of mergers and acquisitions, which has led to a steady decline in the number of listed companies.
Whatever the cause may be, there is a clear concern about the trend. Concentration may ultimately lead to monopolies, with all the associated negative consequences of higher prices and the reduced flexibility. This fear of a world ruled by monopolistic companies is of course hardly new, nor does it seem particularly relevant at this time. For one thing, the world is not a closed system, which means that there is always competition from China or Europe. Complacency is the kiss of death, especially now. Additionally, a company like Apple may currently be one of the top earners, but that is hardly because of its monopolistic hold on the smartphone market. There are plenty of cheaper options on the market and even the mighty Apple may be punished if its iPhones are overpriced.
Maybe the real risk is of a completely different nature, however. The rise of the number of top earners seems to have coincided with that of the so-called zombie companies, whose survival depends completely on creditors overextending financing to keep them afloat.1 The risk in this case is not to monopolistic pricing, but rather to the productivity dynamism of the broader economy. To quote a study by the Organization for Economic Cooperation and Development (OECD), “a 3.5% rise in the share of zombie firms is associated with a 1.2% decline in the level of labor productivity across industries.”
If this is indeed the main cause of the rise of top earners, the solution may be simple: central banks should end the current period of lax monetary policy to weed out those zombie firms. With the current growth momentum in place, now is as good a time as ever, but much depends on how central banks will deal with the sticky issue of the lowflation environment seen in much of the world.
This article forms part of the Robeco 2018 outlook entitled Playing in Extra Time.
1 Using the BIS definition, these are firms whose interest payments exceed earnings before interest and taxes.