Wealth Lost, Not Wealth Preserved, Powers Economic Growth
At a recent investor conference at which I spoke, a poll was taken of the portfolio managers in attendance. The idea behind the survey was to develop a sense of the shares these managers held most commonly. Not surprisingly, the equity holdings accented blue-chip companies; as in a conservative (in the non-ideological sense) bent among the managers.
Apple was the most heavily owned stock, while Johnson & Johnson, Alphabet, J.P. Morgan and others like it weren’t too far behind. “Wealth preservation” would probably be the best way to describe the investing style employed by the investors at the conference. And there’s nothing wrong with that.
For the typical saver, wealth preservation is the highly logical goal. Since it is, the typical portfolio manager generally purchases established companies with fairly predictable earnings streams. No doubt these managers could dial up the risk with potentially higher returns in mind, but doing so would also place the wealth of the client at much greater risk.
Up front, it’s worth saying that the conservative investing style of those in attendance surely redounds to economic growth. The companies previously mentioned are the picture definition of prosperous, and their great health helps explain why the U.S. economy remains the envy of the world.
Ok, but what if the blue chips of today are still the top companies broadly held by portfolio managers ten years from now? If so, as in if the team picture of top corporations is little changed in ten years, the static nature of the honor roll of U.S. corporations will arguably signal something unhealthy about the economy.
If anyone doubts this, they need only consider the blue chip U.S. businesses from the year 2000. When the new century began GE was the world’s most valuable company, Tyco was viewed as the next GE, Enron was a management marvel whose shares were broadly held by the portfolio managers of prominence, AOL was the gold standard of Internet companies, and Worldcom was the future of communications. As recently as 2008, GE, Proctor & Gamble and AT&T were three of the top five most valuable companies in the world. Today, none are even in the top 10; having been replaced by companies like Apple, Alphabet, Amazon, and Facebook. Notable here is that Microsoft has been a top 10 company going back to the 1990s, which says a lot about the business created by Bill Gates.
Useful here is that the constant churn at the top of the U.S. corporate heap is an effect of intrepid investment that fosters the “surprise” necessary for the kind of economic growth that truly makes the U.S. the envy of the world. Many of today’s greats will soon enough be eclipsed by companies we’ve presently never heard of, or if we’ve heard of them, we’d never guess they would dominate in the future. To offer up but one example of how quickly things evolve, when the 21st century began Amazon shareholders were frequently ridiculed for owning that which was supposedly incapable of achieving profits. Apple was three years removed from near bankruptcy. How things change. Crucial to this relentless change is the investment of rich people with money to lose. The rich have the unique ability to purchase substantial shares in public and private companies that, while promising, have high odds of failure.
“Surprise” companies don’t fit the bill of wealth preservation, and they don’t simply because they’ll go completely belly-up much more often than not. As an example, technology investors focused on Silicon Valley have to be very patient when it’s remembered that 9 out of 10 Valley start-ups die. Investors in Valley-style companies must have patience, plus enormous wealth they’re willing to lose the vast majority of the time in order to happen on the rare winner that papers over all the losses. All of this speaks to the essential importance of the superrich to economic progress. Their wealth is the source of immense dynamism in markets richly priced for routine change.
The constant replacement of the companies at the top that’s been described helps explain why U.S. equity markets continue to boom. They do because the future is always replacing the past. What mattered 10, 20 and 30 years ago doesn’t much matter today, and what matters now likely won’t matter as much in the future. If this is doubted, readers need once again only consider the roster of some of the most valuable and admired companies in 2008 and 2000. The team picture always changes.
What this tells us firstly is that the view about the Fed having created a bull market with its QE machinations brings new meaning to naïve. No offense to the many true believers in what’s absurd, but the most valuable companies in 2008 are for the most part not the most valuable of the present. Implicit in the QE narrative is that the Fed not only engineered a rally, but did so while making sure to limit the share performance of GE, Proctor & Gamble and AT&T shares while making sure to lift those of Alphabet, Amazon and Apple. Such a view isn’t serious, nor is the reasoning about QE. Assuming the Fed could prop up markets, as in use its power to maintain the status quo, the act of doing so would crush markets for it propping up the past at the expense of the future.
As for investing more broadly, thank goodness for the existence of investors with different goals. Those in search of wealth preservation are able to put money behind today’s blue chips, while those interested in a little more risk can put their wealth behind the potential replacements for those blue chips; the competition from tomorrow’s companies forcing today’s high flyers to lift their game or be replaced by tomorrow’s surprises. Economic growth is the happy result either way.