Welcome to the Capital Note, a newsletter (coming soon) about finance and economics. On the menu today: Increasing Returns, the Swedish Experiment, and the Twitter Risk Factor, plus some links from around the Web.
There are half as many publicly traded companies today as there were in 1996. Partly due to consolidation and partly due to a lower appetite for public capital, portfolio allocations have seen a broad shift away from stocks and bonds.
A recent Morgan Stanley report attributes the relative decrease in public-equity capital to structural and regulatory changes. First, technological advances have made new firms less reliant on tangible assets and more reliant on intangible assets, such as software, which require less capital to develop. Second, regulation has made the IPO process more costly (in a recent Capital Note, we discussed how that is driving an increase in SPACs), while regulators have grown more lax on mergers and acquisitions.
The rise of capital-light industries has also ushered in an era of increasing returns to capital. Because there are no physical limitations on a software company’s ability to grow its market share, the knowledge economy is one in which the strong (think Amazon, Apple, Google, etc.) get stronger and the weak languish. As W. Brian Arthur put it in a Harvard Business Review essay:
Increasing returns are the tendency for that which is ahead to get further ahead, for that which loses advantage to lose further advantage. They are mechanisms of positive feedback that operate — within markets, businesses, and industries — to reinforce that which gains success or aggravate that which suffers loss. Increasing returns generate not equilibrium but instability: If a product or a company or a technology — one of many competing in a market — gets ahead by chance or clever strategy, increasing returns can magnify this advantage, and the product or company or technology can go on to lock in the market.
The rise of private-equity investing adds other layers to the phenomenon of increasing returns. With fewer winning investments, the most talented private-fund managers significantly outperform their peers. That leads to stratified fund returns, most notably in venture capital, which in turn go to the most sophisticated limited partners, such as elite-university endowments, at the expense of less-sophisticated institutional and retail investors. And because the biggest public companies are sitting on huge piles of cash, they tend to buy up the portfolio companies of private funds, which used to exit many more of their investments through IPOs.
This process creates a few big winners and many losers.
The Swedish Experiment
We have already discussed the way in which (all things considered) Sweden’s companies surprised positively during the second-quarter reporting season.
Sweden’s gross domestic product (GDP) tumbled 8.6% in the second quarter of the year [and 8.2 percent on a year-on-year basis) , according to a flash estimate from the country’s statistics office on Wednesday, recording its largest single quarterly drop in modern history.
The record decline, broadly in line with consensus, was significantly worse than even the fourth quarter of 2008 when the Nordic country recorded a fall of 3.8% during the global financial crisis.
So, the relatively light touch that Sweden has applied to its management of the pandemic has not even helped it out economically?
Not so fast:
The euro zone’s economy contracted by 12.1% in the second quarter when compared to the previous quarter and by 11.9% across the broader European Union. The Spanish economy recorded the sharpest decline among member states when compared to the previous quarter, falling 18.5%.
As I mentioned yesterday, those looking out for trouble in the euro zone would do well to keep half an eye out on Spain, after Italy, perhaps the most likely candidate to trigger a crisis some time in the fall. It is worth remembering that those Spanish data cover the period before the peak vacation season, which is, unsurprisingly, going very badly indeed.
The June data speak for themselves. According to El Pais, the contraction is due largely to tourism, as “just 204,926 international visitors arrived in Spain in June, a drop of 97.7% from the same month in 2019.”
Depending on whom you ask (or, presumably, the methodology used) tourism accounts for anywhere between 11-14 percent of Spanish GDP.
But it is worth noting that the euro zone’s weakness also extended to Germany, where the quarter-on-quarter decline was 10.1 percent. Germany is an interesting comparison, because, in a number of respects, Sweden, with a strong engineering sector and a heavy reliance on exports, is a mini-Germany (exports in both countries account for more than 40 percent of GDP).
The US was down 9.5 percent in the same quarter (note that these are all quarterly rates, not the 30-something annualized rates that grab the headlines).
Writing for the London Spectator, Matthew Lynn:
True, infections were high to start with, and so was the mortality rate from Covid-19, at least compared to its immediate neighbours [partly due to a botched care home strategy, a mistake that was not confined to Sweden]. Right now, however, it doesn’t look as if the final tally will be much different to anywhere else. But the economy will emerge in far better condition, with less lost output, and less extra debt as well.
There is a lesson in that for other countries. Of course it is important to protect health systems and make sure they are not overwhelmed. But it is also important to protect the economy. If you don’t, very quickly there aren’t any jobs to go back to, and there won’t be any money to pay for healthcare or for anything else for that matter. Sweden has done a better job of protecting output than any other major, developed country. And if a second wave does arrive in the autumn or winter, the rest of the world should take note — and not rush straight back into lockdown no matter what the pressure to do so might be.
And if Sweden does not have a second wave, there will be another lesson to be learnt too.
Around the Web
The rent is not quite so damn high:
The table of the 17 most expensive major rental markets by median asking rents shows July rent, the change from July a year ago, and, in the shaded area, peak rent and change from the peak. The “declines from peak” are led by Chicago and Honolulu in the range of -25% to -32%, though they seem to have found a bottom recently. Numerous cities — including some of the formerly hottest markets — are have booked [sic] double-digit declines from their peaks. But Ft. Lauderdale set new records
A wave of credit card defaults on the way?
Despite the coronavirus and millions of jobless claims driving the U.S. economy deeper into recession, the flood of credit card delinquencies that some predicted has yet to materialize. Instead, card debt has actually gone down since the pandemic struck, with many consumers spending less while using bailout money to chip away at balances.
But that may not last. Even if Congress passes a new rescue package with more unemployment benefits, the cumulative effect of the ongoing economic catastrophe may finally trigger that default deluge, a new survey reveals. More than half of consumers with credit card debt said they will need more bailout money to make minimum payments over the next three months, but about the same number said employment will be more critical to avoiding default.
[British finance minister] Rishi Sunak is considering an increase in business rates [property taxes] for the “most valuable properties”, with fears being raised that the move could hurt firms already struggling amid the effects of the coronavirus crisis.
The Chancellor has asked for industry feedback on whether high end shops, offices and other large premises should pay a new, higher business rate, with responses due ahead of the autumn Budget….
On Tuesday, business rates experts described the proposals as “abhorrent”.
Jerry Schurder, the head of business rates at consultancy Gerald Eve, said: “It beggars belief, considering the primary complaint about business rates is that the tax is just too high.”
Mr Schurder said the “most valuable properties” could include large shops, supermarkets, offices, hotels and cinemas.
Random Walk: The Twitter Risk Factor
Pretty much everyone agrees that Twitter carries more risk than reward. A good tweet gets you likes; a bad tweet gets you fired. Trump’s tweets have twice brought us to the brink of war, but he refuses to give up his account, despite the protestations of his advisers.
If you don’t manage to get yourself into trouble, you might get hacked, as Barack Obama, Joe Biden, Elon Musk, and others recently learned after a 17-year-old Bitcoin scammer took over their accounts. That wasn’t Musk’s first rodeo: The Tesla CEO won himself an SEC investigation for his notorious “funding secured” tweet.
So it’s best to stay away from Twitter, right? Wrong.
Using novel corporate Twitter data on all U.S. public firms, we show that firms with a Twitter account earn 50 basis points per month higher returns than similar firms without a Twitter account. This `Twitter premium’ is higher among smaller firms and firms with higher fundamentals uncertainty, and is not explained by existing risk-factor models. Having a Twitter account presents opportunities for value creation but also raises social media risks.
Not only does the Twitter bump account for firm characteristics and risk exposure, but its size is correlated with how much companies tweet: “Firms that increase their tweeting in a given month earn higher returns than firms that decrease their tweeting over the same month.”
Maybe don’t delete your account just yet.
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