Monopolies Alone Don’t Explain Why Stocks Soar
There are many reasons share prices can outpace U.S. economic growth.
Bloomberg, February 23, 2018
Is America becoming a nation of price-fixing, monopolistic rent extractors?
It’s not that this isn’t a bad question. Rather, it is such a sprawling and complex issue that there are no simple or tidy answers. Like the Indian parable of the six blind men describing the elephant, your perspective on the issue shifts depending upon which part of the economy you are looking at.
Let’s try to tease apart this question, to see if we can at least come up with some answers to aspects of this complicated issue. First, let’s summarize the argument, which goes something like this:
— Despite a persistent decline in real interest rates, corporate investment has been disappointing;
— Competition in U.S. has fallen, thus reducing the needed for new capital expenditures;
— Companies free of competitive pressures can set monopoly prices;
— Monopolies underpay their workers, underinvest in their companies and pad corporate profits that boost stock prices faster than underlying economic growth;
— The gains from the huge rise in stock prices have gone to a narrow slice of the populace, mainly top executives and big shareholders.
These statements are more or less accurate, but they are also incomplete. Consider these complications to the idea of a nation of rentiers.
Corporate America is global: The Standard & Poor’s 500 Index consists of companies that sell their goods and services around the world. Faster growth in other nations and the rise of emerging markets might help explain how U.S. corporate earnings can increase faster than U.S. gross domestic product. It reflects the ability of U.S. companies to scale and to be strong competitors in many different markets. When looking at gains of U.S. stock prices, be aware that it might have more to do with the global economy than what’s happening closer to home.
Misaligned incentives: This has been an issue for decades. The financial crisis revealed (yet again) that short-termism is alive and well. Remember when banks sold subprime mortgage securities that they had to know were all but guaranteed to blow up? And does anyone think the intense focus on quarterly results at the expense of long-term growth opportunities has gone away?
As long as this mindset persists, there will be underinvestment and an excessive focus on financial engineering to drive up share prices — which not coincidentally also increase the value of stock options that so many companies now lavish on their top executives.
Capital expenditure versus share buybacks: How much should a company reinvest in itself? That is a question that corporate management is supposed to address, without giving excessive weight to short-term profit considerations. Given those conflicting incentives, it easy to see a reason why some companies have skimped on capital expenditure. On the other hand, some of the stock market’s biggest winners include companies such as Apple Inc., Netflix Inc., Amazon.com Inc. and Alphabet Inc. (Google) — all of which plow billions of dollars back into research and development. (We talked before about why investors should prefer increased dividends over buybacks.)
Monopoly and technology: Here is where things get really challenging. Some of the companies that look more like monopolies are among those have reinvested the most in their businesses. And they hardly engage in what we think of as traditional monopolistic behavior.
Don’t like Google search? The company does nothing to stop you from looking for stuff on the internet with Bing, or Dogpile or DuckDuckGo. Are you an Apple fan like me? You are free to buy a Windows PC or an Android phone. I shop at Amazon constantly, but when I needed a new tennis bag, nothing prevented me from going to Tennis Warehouse.
Alphabet, Apple and Amazon all offer outstanding products and services that you and I are comfortable using all the time, often to the exclusion of other businesses that offer comparable — sometimes even superior — goods and services. Our inertia doesn’t make their businesses monopolistic.
Winner take all: Which leads us to the thorniest issue: relatively small differences in performance give rise to enormous differences in reward. Cornell University economics professor Robert Frank (MiB interview here) identified this issue two decades ago and it seems more prevalent than ever.
The modern era is filled with confirmation biases and self-imposed media bubbles. One of the most challenging things in this environment is engaging in the reasonable exchange of ideas with the people with whom you disagree. It is an undertaking from which there is no quarter.
The issue of rent extractions and monopoly profits is a perfect example. It is an important question to debate and think about. But it doesn’t offer complete answers to the question of the disconnect between the stock market and the economy.