WHICH firms have emerged as the winners from the chaos of the past three years? Perhaps the most unusual period for business in a generation began in the spring of 2020, when lockdowns brought parts of production to a standstill. A deep but brief recession was followed by a frantic recovery. Then came inflation. A world economy already in the grip of a high-speed cycle is now experiencing the fastest increase in interest rates since the 1980s. Graham Secker of Morgan Stanley, a bank, argues that the policy response to covid-19 has shocked the economy out of secular stagnation—the slow-growth, low-inflation malaise preceding the pandemic—and marks a new era.
It should be no surprise that the business environment has changed profoundly. To take stock of this we have examined which American industries and firms have performed best over the past three years, based on stockmarket performance. The headline is that market leadership has flipped dramatically. The digital hares have given ground to old-economy tortoises. Big tech is no longer running away with the race. Firms once derided as obsolete and sluggish suddenly look vital again.
We have chosen January 1st 2020 as the starting date for our analysis. Since then, the S&P 500 index of leading American shares has risen by 25%. The best-performing industry sector is energy, followed by information technology (IT). Health care has done well, as might be expected during a public-health crisis: the second-best-performing company in the S&P 500 is Moderna, a leading vaccine-maker, whose share price is up by no less than 800%.
Industrial companies have kept pace with the index, as have consumer staples. Firms that serve discretionary parts of consumer spending, hurt by inflation, have lagged behind. The worst-performing sectors are real estate, banks and communication services (see chart 1). And at the very bottom of the performance league are cruise-liner firms, such as Carnival, that have seen their debts soar and their shares drop like an anchor towards the ocean floor.
Measuring performance by share prices has its flaws. It is hard to look at the roller-coaster stock price of Tesla (up by 556%) without being mindful of the influence of investor fads and shifts in risk appetite. But over time, business success is embedded in market prices. It also helps to understand how investors’ perceptions have shifted over time. To capture this we have split the period into three stages. The stay-at-home phase, the reopening phase, and now the inflationary stage.
The signature investments of the pre-pandemic era of secular stagnation were asset-light companies: principally software firms, which benefit from network effects, but also branded-goods companies. Firms based on ideas and information were favoured over ones that relied on physical capital. The trade was to buy “bits” and sell “atoms”.
The first part of the pandemic amplified these trends. The stay-at-home phase lasted until November 8th 2020, the day before the test results of the Pfizer vaccine were announced. The big winners were tech, consumer discretionary (Amazon rose by 79%) and communication services (Netflix was up by 59%). The losers were real estate, banks and energy. There is little mystery to this. Stuck indoors, people relied on software and deliveries. Offices were barely occupied; there was little driving or air travel (bad for oil firms). And banks were hit by lower interest rates and fears of defaults.
In the next, reopening phase, leadership shifted. Energy was the big winner, followed by financials (buoyed by optimism and rising asset prices), tech and real estate. Inflation emerged as a theme, but at that stage was seen as a symptom of growth and not yet as a threat to it.
In the third phase, which began at the turn of this year, the Federal Reserve has pivoted from being relaxed about inflation to being spooked by it. Expectations of interest-rate increases have risen and the stockmarket has slumped. All sectors except energy have been crushed. Among the worst hit have been the winners of the first phase: tech, consumer discretionary and communication services. The time-horizon of investors has shortened. The share prices of businesses whose earnings power is projected furthest into the future, notably tech, have been trashed. Atoms are now back in favour.
Three long years
If you look over the entire three-year period the best-performing industries are energy and IT: respectively the archetypes of the “value” style of investing and its antithesis, “growth”. The sequencing of their performance has been in mirror image. Energy—particularly oil firms, such as ExxonMobil and Chevron—had a terrible 2020 followed by two bumper years. Oil has gained back more than it lost.
Technology firms had two blowout years before a reckoning in 2022. But there is plenty of dispersion. Within the big-tech category of the very largest firms there are big gaps in performance: shares of Meta, the owner of Facebook, have lost almost half of their value even as Apple’s shares have soared (see chart 2). The share price of Nvidia, a chip designer, is up by 177%, even as those of Intel, a chip pioneer from an earlier age, slumped.
Which of the trends of the past three years will persist and which will prove more transitory? Tech is running into structural problems. The firms that grew rapidly in the 2010s, such as Amazon and Netflix, are now maturing businesses. The tech giants compete more vigorously with each other. Now that they are so big, if demand in their particular market is dented, they cannot avoid the pain.
The original attraction was that tech firms were capital-light. Once a digital platform is set up, adding more customers does not add much to costs as it would for a traditional firm. “Amazon got to 5% of US retail sales much faster, and using much less capital, than it took Walmart to get to 5% of US retail sales,” says Robert Buckland of Citigroup, a bank. Yet it has become more apparent that big tech relies on atoms as well as bits. Mr Buckland notes that Amazon’s capital budget next year is more than twice as large as ExxonMobil’s. Meta has already spent a small fortune on establishing a virtual-reality platform, of which investors have taken a dim view. Netflix’s margins have been squeezed by the higher spending on content.
It follows that the ability to marshal capital and use it efficiently is likely to become a key differentiation for performance in the new era of higher rates. Oil companies used to be notorious for blowing profits on exploration. But pressure from shareholders to improve returns on capital invested and the stigma associated with new investment in fossil fuels has raised the bar for deploying capital. These days it is big tech that blows cashflows on capital spending. Whether mature tech companies can find more discipline will determine whether they can perform better.
More broadly, the increased cost of funding will give a lift to established firms across the economy. When capital is abundant, almost any venture can get funding. Tesla’s boss, Elon Musk, exploited the period of bountiful capital and investor patience to build an electric-vehicle powerhouse that poses a mortal threat to General Motors and Ford. Now that capital is much scarcer, a would-be Tesla would not get such generous backing, tilting the scales towards companies that can generate cash from legacy investments. Incumbents can feel less threatened by potential disruptors.
The upshot of all of this is the hare that is technology, while by no means lame, is not as pacy as it had once seemed. Meanwhile the old-economy tortoises have emerged from their shells with a surprising spring in their step. Still, the strangest business cycle in living memory is not over yet. Expect more surprises. ■
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