The advisory panel met against the backdrop of yet another looming election. As well as touching on a few of the usual questions (such as central bank actions and inflation versus deflation), topics of conversation included, but certainly weren’t limited to: the incredible growth rates of the technology majors; levels of consumer credit (high) and the ability and desire of the banks to create money (lacking); the range of possibilities for Brexit; passive investing and ETFs.
We highlight a couple of areas the panel touched on here:
Industry longevity, concentration and the Herfindahl index
For all the talk of disruption across the economy, the Herfindahl index (a measure of market concentration) shows that the market is becoming increasingly dominated by a small number of very powerful companies. For an academic discussion of the increase in concentration in the US is available here. This increasing concentration may be put down to two main factors: the preponderance of complex regulation that is extraordinarily expensive for smaller companies to navigate (therefore benefiting the big and incumbent – think Sarbanes Oxley); and the accommodative competition policies of governments worldwide (allowing the majority of mergers to go through uninhibited thereby encouraging the big to get bigger).
The importance of this, is that it may well be why we aren’t seeing corporate profit margins falling from persistent highs.
In many areas of the market, we now see two diametrically opposing forces. Increasing concentration supporting higher margins, and increasing disruption forcing them lower (as has often been discussed around this table). For instance, banks with their bloated cost bases, bureaucratic service levels and legacy businesses and systems, should be an attractive target for a clever and nimble competitor. So will we see a proliferation of smaller competitors rising in profile, or will stifling regulation and scale continue to allow the big to get bigger? If governments start to move against “Big Corporate” (either by more flexible regulation; or through more powerful competition authorities), then the corporate landscape may begin to look very different.
Long duration equities
An interesting implication of lower interest rates is the impact it has on evaluating equities. Duration is more often thought of in terms of bonds, as a measure of how far into the future interest or capital is received. The longer the duration, the more sensitive a bond is to a change in interest rates. However, the same logic can be applied to equities. “Growth” stocks, where a larger proportion of cash flows are projected to occur further into the future than their “value” counterparts, can be considered as “long duration equities”. Long duration equities would benefit disproportionately from low interest rates. However, any rise in interest rates from current levels could prompt a reversal of that trend.
Peter Hollis, Russell Napier, Angus Tulloch and the Kennox investment team.