What companies should be prioritising this decade
In a world beset by uncertainty, companies should be prioritising slack over efficiency, says Merryn Somerset Webb.
There are many reasons why US stocks have massively outperformed over the last few decades – low interest rates have helped, as has the stunning success of America’s tech giants. But the huge gains have also been about America’s embrace of “optimisation”, says Edward Chancellor on Breakingviews.
In the name of efficiency, US companies have run down inventories and contracted out their manufacturing to the other side of the world (mostly to China) and replaced as much equity as possible with debt. This has worked absolute wonders for their return on equity (ROE). Last year listed US companies produced an ROE of 17% – against a mere 9% in Japan. No wonder investors have been keener on paying more for the former than the latter. Until now at least.
The new world is not like the old: “optimisation has rendered the corporate world more fragile”. Indebted companies are very vulnerable to recession and rising interest rates.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Those dependant on offshore manufacturing are vulnerable to supply-chain disruption – something that became nastily obvious during the pandemic – and given the war in Ukraine and endless brutal lockdowns in China this is clearly not a short-term problem. This tells us something very important about the thing companies should be prioritising in the 2020s: not efficiency, not optimisation, but slack.
Vertical integration is making a comeback: some luxury-goods brands are buying up their suppliers and chip giant Intel is planning to build its own plants in the US and in Germany. Just-in-time manufacturing is on the way out. Reshoring (something we have been talking about for some time at MoneyWeek) is very much on the way in.
The search for slack
The problem, of course, is that slack is hard to find, as the inflation numbers show: US inflation is now running at a 40-year high of 8.5%. There is significantly less than is comfortable in energy, far too little in most metals (including uranium) and nowhere near enough in agriculture.
How should investors react? First, make sure you are not overinvested in the companies that are going to need to buy in slack by moving manufacturing onshore, by cutting back on debt levels and by holding high levels of inventories (and which will have to take the hit to their margins and share prices and all that implies).
Second, invest in the firms that will be lack-of-slack winners – think about the fossil-fuel and mining companies that have been relatively capital starved over the last decade. Lack of supply and rising prices will be very nice for them. Of that 8.5% rise in US prices, 32% of it was down to rising energy prices.
Third, look for companies that never gave up their slack in the first place and have been underpriced as a result. There are still opportunities in the US. But for Chancellor this new dynamic means you have to look at Japan, “one of the few developed economies to have retained its manufacturing base” and one in which many companies still operate “with plenty of redundancy”.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
-
Higher rates are disappearing – should you fix your savings?
Fixed savings rates have dropped to their lowest levels in over a year. Should you fix your savings now ahead of a potential base rate cut in November?
By Katie Williams Published
-
Nine million people fall victim to financial scams, says Citizens Advice
The charity says that around one in five people across the UK have been caught out by a finance scam in the past year - here is how to protect your money
By Chris Newlands Published
-
Working from home: is it working?
While Labour plans to make working from home the legal default, some employers are calling workers back into the office. What does the future hold?
By Simon Wilson Published
-
Israel conflict: the concerns of a wider war
Israel's raids into Lebanon have raised fears of a wider war
By Dr Matthew Partridge Published
-
Why did Britain give the Chagos Islands back?
What is the deal with the Chagos Islands and what role do the Tories play?
By Emily Hohler Published
-
Can Lebanon's struggling economy survive another war?
Lebanon's economy has been in dire straits for decades, and now it is yet again on the brink of war. Are better times on the horizon?
By Simon Wilson Published
-
Modi’s reforms set Indian stocks on fire
Indian stocks pass a new milestone, but global fund managers are holding back. Are there signs of overheating?
By Alex Rankine Published
-
How to improve economic output using the supply-side approach
Boosting potential economic output through public investment is crucial, says David C. Stevenson
By David C. Stevenson Published
-
Is China following Japan's economy and stock market?
China is dealing with deflation and an unappealing stock market. Is it following in the footsteps of Japan?
By Alex Rankine Published
-
Will Mpox be the new Covid?
Not if Mpox can be contained, says the World Health Organisation. But will it be?
By Simon Wilson Published