December 12, 2017
Market Concentration Helping Upend Conventional Wisdom
The stock market has become more concentrated in a winner-takes-all world.
In recent years, markets have become more concentrated as dominant players such as Amazon, Facebook and Google have disrupted entire industries. Those dusty economic textbooks many of us have moldering in our attics tell us that increased market concentration means less competition, which should result in higher prices. But what we’ve seen lately suggests the opposite may be happening. Even though there are fewer, larger competitors on the playing field, these giants are competing on price, as they are often more concerned with growing scale rather than their bottom lines — particularly in the digital space. They are playing a game of winner take all, and the winners are winning big.
How concentrated have markets become? The number of publicly traded companies in the United States is roughly half of what it was 20 years ago. Today there are around 3,600 listed companies, down from about 7,300 in 1996.1 Given the growth in the US economy over the past 20 years, we should have seen a rise, on net, of thousands of new public listings — as was the case in the last few decades of the twentieth century. Instead, the number of publicly traded companies has continued to dwindle, as many companies have been swallowed up by competitors, have been scooped up by private equity funds, have decided the costs of going public are not worth the benefits or have simply gone out of business. Those larger and older companies that remain tend to garner a disproportionate share of earnings and assets and pay the most dividends, as illustrated in Exhibit 1.
Why should we care about corporate concentration? In a word, innovation. Small firms traditionally have been a significant source of dynamism, creating new technologies and building new products consumers don't even know they want, like social networks. However, today, only the largest, most mature companies have the resources to deal with increasingly complex and costly government regulations. And if the world continues down the path of economic nationalism, the bar will get even higher. This dynamic is helping to squeeze out smaller firms, resulting in less vitality and, ultimately, less innovation.
A clear example of increased concentration is at the growing intersection between traditional brick-and-mortar retail and e-commerce. Amazon has built its digital presence to an unrivaled scale largely by focusing on undercutting competitors on costs. Amazon is now edging onto Walmart’s home turf with its recent acquisition of Whole Foods Market, giving it the brick-and-mortar presence it formerly lacked. Meanwhile, Walmart has made significant online inroads after purchasing Jet.com and several other digital retailers. In the coming years, the rest of the industry may be left struggling for survival, which will likely lead to even more concentration.
History does not provide a good guidepost for what we're seeing today. The last time we saw a similar level of market concentration was during the Gilded Age of the early twentieth century, when Rockefeller, J.P. Morgan, Vanderbilt and Carnegie were dominating their respective industries. As one would expect, these industry giants turned the lack of competition to their advantage by raising prices and maximizing profits. That's not happening today. Walmart has been a price leader for generations, and Amazon has taken the baton in recent years. At some point, once it's achieved some as-yet-undefined level of scale, Amazon may look to boost the bottom line, but it doesn't appear to be in any hurry to do so. So we can expect cutthroat price competition to remain, which will be disinflationary in the near term. This is important, as it helps to keep inflation expectations low and contributes to a lower-for longer interest rate paradigm.
Concentration may also help restrain market volatility. Most large companies today tend to be more stable, better known and more closely analyzed than before. Additionally, there are fewer owners of these companies than previously, given that ownership of public companies has become increasingly concentrated in the hands of a few extraordinarily large money managers, especially with the rise of passive investing strategies. Today, there are more price-insensitive investors than ever before. While volatility will spike at some point, we could live in today’s low-volatility world for a long time. Against a backdrop of low volatility, credit spreads could also be lower for a longer period of time. Additionally, equity price-to-earnings ratios could remain elevated amid these benign market conditions. This is not to say that volatility and credit spreads won't rise or that P/E ratios won't fall, but rather that they could remain at historically extended levels longer than past experience might suggest.
Finally, market concentration may be calling into question the conventional wisdom that, over the course of business cycles, small-cap stocks outperform large-cap ones and that value stocks outperform growth. In a winner-take-all world, large incumbents do well and small companies have a hard time gaining traction. This bears watching, as corporate tax reform should favor small, value stocks in the US, given their largely domestic orientation — but we think this may be a one-off. So, we may need to rethink the notion of owning small cap and value over large cap and growth in a world where winner takes all.
1Is the American Public Corporation in Trouble? Kathy Kahle and Rene Stulz, 2017.
The companies referenced are used for informational purposes only, and do not necessarily represent holdings in any MFS portfolio.
The views expressed in this commentary are those of Erik Weisman and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any other MFS investment product.
This content is directed at investment professionals only.