Shifting political attitudes could have a significant impact on certain companies and the economy as a whole
Political opinion in the US and UK seems to have shifted in the past few years. In particular, we have begun to see greater scrutiny of capitalism and how the system operates, with people far more willing to criticise the global tax system, the share of GDP going to workers and the authorities’ approach to competition law and company interactions.
The latest example of this was US senator Elizabeth Warren’s speech to the Open Markets Institute. Warren criticised the growing monopoly power of corporates, arguing it has driven up prices, crushed innovation and undermined wages.
The correct response, in her opinion, is for governments to take a tougher line with companies, enforcing free markets and actively tackling “concentrated market power (which) also translates into concentrated political power”.
This is a marked criticism of capitalism and one which I think represents a wider shift of attitudes across the political spectrum. If these ideas gain traction, it could have a significant impact on certain sectors, as well as having wider consequences for the economy as a whole.
Which areas are at risk?
The best example of a sector with high levels of concentration and high margins is technology. Many technology stocks benefit from high margins, with little doubt that some companies are earning economic rent.
In a free market, this should be a temporary reward for innovation that is gradually eroded by competitive forces.
But there is little sign of these forces at work and regulators may start intervening to increase competition or, if that proves difficult, to reduce the economic rents companies can earn.
The latter course of action is a particular risk where network effects create natural monopolies.
Google, for example, now has about a 90 per cent market share in online search, and is beginning to see legal disputes arising from how it exploits that position. So long as consumers benefit, legal or regulatory challenges may be able to be held at bay.
The difficulty may come if some companies appear to be exploiting their monopolistic positions. Amazon’s share price performance is a clear indication that markets expect the company to switch from emphasising market share to emphasising profitability at some stage.
It may then be able to earn excess profits for a prolonged period if it has crushed competition along the way. That may also be the moment when the regulatory noose starts to tighten.
How real are the risks?
For now, investors seem relatively relaxed about the possibility of anti-trust actions against companies with high market share. One reason is that few customers are complaining. Another is that there is no compelling message or messenger on the topic.
Warren puts forward a coherent argument but is widely seen as part of the US establishment, making her untrustworthy in the eyes of much of the electorate.
Interestingly, however, the merger arbitrage managers we speak to (whose investment approach is based on spotting takeover targets and M&A deals) suspect that the merger approval process has become politicised under the current administration, or more erratic at least.
While President Trump and his administration have not espoused the same criticism of corporate power as Warren has, it should concern investors that competition regulation is becoming more political, and that Trump has picked on companies like Amazon for being no-tax monopolies.
At a time when capitalism is coming in for increased criticism, investors should be careful of companies which have significant market power. They may also want to review some elements of their investment process.
Analytical models like Porter’s Five Forces, for example, where the ability of a company to sustain its profitability is based on its competitive power, may need to be re-evaluated in a more active regulatory environment.
Investors should not necessarily fear the potential for change, though. Increased scrutiny of the monopoly power of corporates might lead to economic benefits.
Analysis from Nomura suggests one reason for lacklustre US wage growth has been the unwillingness of workers to switch jobs, for example. If labour market power increased as the power of employers diminished, it could lead to faster wage growth and higher consumer spending.
More generally, change creates winners and losers – the raw material of successful active management. Attitudes to capitalism will increasingly preoccupy investors over the next five years. It might seem strange to be talking about more burdensome regulation when the current US administration is one of the most pro-business in decades. But the forces that led to Trump’s election may not always be positive for investors, and new sectors of the economy like technology might want to be warier than most.
Bill McQuaker is portfolio manager of Fidelity’s Multi Asset Open Range