The new winners and losers in business

WHICH firms The winners of the chaos of the last three years are now? The spring of 2020 saw lockdowns bring parts of the production to a halt, making it perhaps the most unusual time for business in a generation. The recession was short-lived but it was followed by a swift recovery. Inflation followed. An already high-speed world economy is experiencing the largest increase in interest rates in over 30 years. 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’s not surprising that the business environment has undergone significant changes. We have compiled a list of American firms and industries that have done well over the past three year based on their stockmarket performance. Market leadership has changed dramatically, according to the headline. Digital hares are now being beaten by old-economy tortoises. The race is not over for big tech. Companies once regarded as slow and obsolete suddenly appear vital.

Our analysis began on January 1, 2020. Since then, the S&P 500 index of American shares leading in the market has seen a 25% increase. Next is information technology, which is the second-best performing industry sector.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 major vaccine-maker whose share price has risen by 800%.

As has the index for consumer staples, industrial companies have kept up with it. The index has been slowing down for firms that provide discretionary services to consumers, which have been affected by inflation. Real estate, banking and communications services are the worst performing sectors (see chart 1). The worst performing sectors are real estate, banks and communication services (see chart 1).

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It is not a good way to measure performance, as share prices have their flaws. It is difficult to consider the Tesla stock price, which has risen by 556% in a short time, without thinking about the influences of investor trends and changes in risk appetite. Market prices are a reflection of business success over time. It also helps to understand how investors’ perceptions have shifted over time. We have divided the period into three parts to capture this. The stay at-home phase, reopening phase and now the inflationary step.

Asset-light companies were the most prominent investments in pre-pandemic secular stagnation. These included software companies, which are able to benefit from network effects, as well as branded-goods firms. Firms that were based on information and ideas were preferred to those that depended on capital. The trade was to buy “bits” and sell “atoms”.

These trends were amplified in the first phase of the pandemic. The stay at home phase was in effect until November 8, 2020, just before the Pfizer vaccine test results were released. Tech, consumer discretionary (Amazon rose 79%) and communication services (Netflix rose 59%). Real estate, banking and energy were the losers. This is not surprising. People were confined to their homes and relied on software deliveries and delivery. The offices were not occupied and there was very little flying or driving (a problem for oil companies). The fear of defaults and lower interest rates also hit banks.

The next phase of reopening saw leadership shift. Next came energy, then financials (booted by optimism & rising asset prices), and tech and realty. While inflation emerged as a theme, at that stage it was seen as a symptom and not a threat to growth.

The Federal Reserve has changed from being more relaxed about inflation to being scared by it in the third phase. It began at the beginning of the year. The stock market has declined as investors have become more optimistic about interest rate increases. All other than energy, all sectors were affected. The first phase’s winners, including tech, consumer discretionary and communications services, were the most severely affected. Investors now have a shorter time-horizon. Stock prices for companies whose earnings power is projected far into the future, including tech, have dropped. Atoms are back in favor.

Three long, happy years

Looking back over the three-year period, the top-performing industries are energy. IT: respectively the archetypes of the “value” style of investing and its antithesis, “growth”. Their performance sequence has been mirror-image. Energy—particularly oil firms, such as ExxonMobil and Chevron—had a terrible 2020 followed by two bumper years. Oil has seen its losses offset by gains.

Two years of blowouts were experienced by technology firms before the reckoning in 2022. However, there is still a lot 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). Nvidia shares are up 177% despite the decline in Intel’s share prices, a chip innovator from a earlier time.

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Which trends from the past three years will continue and which will be more temporary? Tech is experiencing structural problems. Amazon and Netflix, two of the fastest growing tech companies in 2010, are now mature businesses. Tech giants are now competing more fiercely against each other. They are now so powerful that if there is a decrease in demand for their market, they can’t avoid it.

The initial attraction to tech companies was their capital-lightness. After a digital platform has been established, adding customers is not as costly as for traditional firms. “Amazon got to 5% of US Retail sales are much more rapid and require less capital than Walmart did to reach 5%. US retail sales,” says Robert Buckland of Citigroup, a bank. But it is now more evident that big tech depends on atoms and bits. Mr Buckland notes that Amazon’s capital budget next year is more than twice as large as ExxonMobil’s. Meta has already spent some money on the creation of a virtual-reality platform. Investors are not impressed. Netflix’s margins have been squeezed by the higher spending on content.

Therefore, the ability to efficiently marshal capital is expected to be a key differentiator in the new era with higher rates. Exploration was once a major profit center for oil companies. However, shareholders have pushed for higher returns and there is a stigma attached to new investments in fossil fuels. This has made it more difficult to deploy capital. Today, it is the big tech companies that are wasting capital. It will depend on whether mature tech companies are able find more discipline to be able perform better.

In general, established companies will benefit from the higher cost of funding. Capital is available to almost all ventures. 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. A Tesla-like company would not be able to get the capital it needs, and would instead favor companies that have cash from their legacy investments. Potential disruptors may feel less threatened than incumbents.

All of this shows that technology, although not necessarily slow, isn’t as easy as it once appeared. The old-economy turtles have emerged with surprising spring in their steps. But the most bizarre business cycle ever recorded is not over. Expect more surprises.

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