The Wilshire 5000 Index was introduced in the mid-70s, and at that time, shouldn’t be too terribly shocking, there were about 5,000 publicly traded companies in the United States. Over the course of the next 20 years, that number rose to about 7,500. Interestingly, over the last 20 years, that number has declined and it’s now at about 3,500. There are a lot fewer publicly traded companies in the United States.
In fact, these large companies are taking a larger and larger part of the playing field for each particular sector. This is a little bit strange. It’s not happening that much in other countries. We basically have a publicly traded company deficit in the United States. The bottom line is, there are fewer and fewer companies that are taking the playing field, and therefore, these companies tend to be larger companies. They’re older companies. They’re companies that we know. It becomes more and more difficult for small and new companies to enter the playing field.
Historically, those small and new companies tend to be the ones that are innovative. They’re the ones that push the envelope. They’re the ones that force the incumbents to have to be more innovative, more creative, more competitive. When we take those smaller and newer companies off the field, it should be a bad thing for the economy. It should mean less innovation. It should mean less job growth. We should be a little bit worried about that.
The other thing that’s really interesting about this dynamic is the textbooks would tell us, as there are fewer and fewer companies in any given sector, and you get sort of an oligopolistic outcome, few companies that control their space, prices should go higher and consumer welfare should fall. But what we’re actually seeing, and especially in some of the digital spaces, is that these companies are competing on price. So, prices are actually falling and consumers are better off because prices are lower.
So, why should we care? Why is this a problem? Well, it could be a problem, again, because we’re not seeing the kind of competition that we would want to see. We’re not getting the innovation. We’re not seeing the new job growth from smaller companies, but let’s abstract from that for a minute and ask, what does it mean in terms of markets? What does it mean in terms of finance?
Well, about 25 years ago there was a really important paper that came out from Fama and French that told us that you could extract rents over the course of a business cycle by buying value companies over growth companies and buying small cap companies over large cap companies. That’s worked out pretty well over the course of the last 25 years through the business cycle.
In a world, though, where winner takes all, it’s the incumbent companies that tend to do better. We might want to reinspect this notion that you can extract rents from value companies and small companies over the course of long periods of time. In a world where winners take all, it might be the case that these growth companies and these large companies, the ones that we know so well, are the winners and you might want to place your bets there rather than what the conventional wisdom would tell us.
Erik Weisman is Chief Economist and Portfolio Manager at MFS, a sponsor of Cuffelinks. The views expressed are those of the speaker and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor.
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