Retail and many institutional Investors are flummoxed when pressed to frame a response to the simple question:
“With the US GDP decline of more than 1/3 in the first half of 2020, why aren’t stocks down equally, or worse, considering that equities represent a call on economic growth?”
In reply, institutions read prepared statements, carefully crafted by their compliance and marketing departments, indicating that equities look forward, not backward, that some sort of economic recovery is all but assured and therefore equities are anticipating this assurance. Retail and institutions also talk up the record low interest rate environment, several rounds of stimulus and possibly more stimulus to come. Finally, both retail and institutions trot out the old adage “don’t fight the fed” as a rationale to hold equities, despite abysmal global economic reports.
All of these explanations are feasible, prima facie, but hardly ground-breaking in the light of such a massive economic contraction. Perhaps there is a simpler and more realistic solution staring us squarely in the face.
Publicly traded companies typically represent the largest companies in any economic sector. Large public firms possess the easiest access to capital. Not only can they access traditional credit readily, public companies can occasionally directly tap into government funding. They can issue equity to the markets, which are an important funding source unavailable to private firms. Public firms control the largest marketing budgets and possess the ability to lobby, quite effectively, in order to influence legislative policy setters.
Private firms have only one advantage over public firms in a recessionary environment and that is the ability to hide bad news from public scrutiny.
Back to the question at hand; why are indexes so resilient, relatively speaking, against the backdrop of a US economy that is only 2/3 the size it was a year ago? My answer, to be thrown into the ring for further exploration if/as/when the pandemic is either accepted or resolved, is that the economy IS smaller, but the large public companies have permanently CAPTURED incremental market share from smaller private competitors. The larger firms, I would argue, are effectively profiting from the economic crisis at the direct expense of smaller companies. The lobbyists of large companies have artfully engaged in the crafting of stimulus programs that benefit their top lines but that do not offer commensurate benefits for smaller firms. One might even suggest, if they were downright conspiratorial, that certain policy decisions undertaken by national governments resulted in economic shutdowns far more harsh than were necessary so as to hasten the demise of weaker firms, in order to push market share towards larger companies. An elimination of competition is also beneficial to operating margins going forward. Therefore, it might be postulated that as in the event of an economic expansion, the largest companies may wind up with even higher profit margins than were earned during the prior expansionary period.
The stealing of market share, which is incredibly difficult to wrest back from larger firms in any recovery, is a traditional, but oft ignored, aspect of recessionary periods. Economic growth tends to reward smaller companies, who traditionally operate with lower margins. Economic rewards to smaller firms is BACK-ENDED in economic expansionary periods. At the outset of any economic expansion, companies tend to have ample supply of surplus capacity, and this capacity doesn’t always get taken up fully until late in an economic cycle. Large companies, therefore, don’t tend to cede market share until they are operating at largely full output, which happens years after any economic trough. Small companies, which are traditionally private, don’t have a great record of wresting market share from larger firms. They only nibble away at market share that is marginally profitable for larger firms or that larger firms determine is not worth adding additional capacity to pursue.
This current recession, whether it be brief, or is of indeterminate duration, will be more punishing than usual, I believe, for smaller firms. Given the reaction, or relative lack thereof, by larger firms, the GDP decline looks to be quite the godsend for “big business” from a long term operations perspective. The hobbling of competition is always good for incumbents. The rich get richer and the big get bigger.
The overall economy of the United States is awful, truly awful. The stock market belies this, but the stock market only represents a snapshot of the economic overview of listed firms. This contraction is hurting smaller and non public firms far worse than it is impacting public large companies. That’s the simplest answer to the discrepancy of reasonable capital markets vs the worst two consecutive GDP quarters reported for the past hundred years.
Acceptance of the view that “the rich get richer” represents an underpinning of a rationale for owning large, secular and largely non-cyclical investments within the Gnostic Global Portfolio. Thus far in this economic contraction, the lack of investment actions required, during this most unsettling time, have followed from the view that larger companies are the appropriate investments to be held during recessions.