MARKET PERSPECTIVE
By J Mulraj
JUNE 15-21, 2024
Long term growth being ignored in pursuit of short term profits
In the late 80s Japan and Germany were economies growing fast enough to threaten the dominance of USA. Both of them used ‘stakeholder capitalism’ to drive corporate growth, and their economies. Under stakeholder capitalism the interests of all stakeholders viz employees, customers, suppliers and financiers, are taken into consideration. It’s economic hegemony threatened, USA reacted to the challenge posed by them, by promoting ‘shareholder capitalism’. Under this, the interest of financiers, (shareholders and banks) were considered foremost and those of other stakeholders were subservient. It worked! The US retained its economic hegemony, even as Japan’s growth, and its stockmarket, stagnated.
One of the components of shareholder capitalism is the mutual fund industry. America encouraged its growth, and the fund industry in USA now has more assets under management (USD 25 trillion) than does its banking industry (USD $ 23t.). Prior to the MF industry growth, individual shareholders held 2/3 rd corporate equity, and institutional shareholders 1/3 rd. Now, it is more than reversed. Institutions hold 80% and individuals 20%.
Holding 80% of corporate equity gives institutional investors huge clout to affect corporate decisions. The fund managers pressurize corporate management to deliver improved quarterly results. They do this because their own compensation has a significant variable component, linked to short term performance of the fund benchmarked against an index.
But this pressure on corporate managers to deliver good quarterly (short term) performances has other ramifications. Watch this clip where, at a senate hearing, Senator Hawley castigates Boeing CEO David Calhoun for sacrificing safety standards for improving short term performance. As of Feb 2024, there have been 529 Boeing 737 accidents costing 5779 lives.
He was paid $32.8 m, a 45% raise over the previous year. Boeing is under federal investigation for falsifying hundreds on safety inspection records.
Another example, mentioned in one of my previous columns, was of Lucent Technologies, earlier Bell Labs, the font of innovation at AT& T, also called Ma Bell. After AT&T was split into 7 Baby Bells, Lucent made an IPO, due to which its management came under shareholder pressure to show improved quarterly performance. He did, but by deferring capex for long term growth and by fudging accounts. Ultimately Lucent was merged into a French telecom company.
So there ought to be thought on some of the things the practice of shareholder capitalism has morphed into.
As mentioned, 80% of US corporate equity is held by institutions, who hold the voting power. The asset managers often depend on external agencies, proxy advisory firms, to guide them on how they should vote, so individual investors who invest in mutual funds have, in effect, outsourced their voting to the funds who, in turn, have outsourced it to proxy advisors. Needs a rethink, at least a tweak.
The pay structure of fund managers also needs a rethink, collectively by the industry. The fund manager’s pay has a large variable component, linked to short term performance vis a vis an underlying index. Such focus on short term is often at the cost of long term sustainability. Needs a rethink.
To illustrate, American companies, under pressure to improve margins constantly, had outsourced manufacture to cheaper locations, such as China. The risks became evident after Covid hit, and the zero tolerance policies of Xi Jinping disrupted global supply chains.
To be fair, ‘shareholder capitalism’ has, in general, worked well. The above examples are to highlight some cases where it has swung to an extreme and for which some rethink is needed.
It’s worked beautifully for the top three American companies whose market cap exceeds $ 2 trillion each. Nvidia leads, with a $3.3 trillion m. cap, larger than the combined market cap of all 30 stocks in the BSE Sensex.
Last week the BSE Sensex closed at 77209, up 117 points over the week.
What do investors need to watch out for?
Other that geopolitical events, a major threat comes from the US banking sector. A potential crisis is brewing in the Commercial Real Estate sector, which will pull down several community banks.
But a bigger crisis lies in the fact that US banks have unrealised losses aggregating $550 b. Banks hold US Treasuries and classify them as either ‘held to maturity’ or ‘available for sale’. When interest rates rise, they have risen 5% over a year, the value of the T Bills falls. If marked to market there’s a $550 b. unrealised loss. That’s far higher than the trigger for the 2008 global financial crisis.
Thus, whilst the India story is good, with favourable demographics, generating adequate domestic demand, the digital thrust provided by the JAM trinity (Jandhan, Aadhar, Mobile), the Government focus on infrastructure build up and green energy, and the impressive monthly flows into systematic investment plans of mutual funds, of over Rs 18,000 crores; the global picture is murky. During the 2008 GFC emerging markets had fallen more than developed markets had.
Optimism laced with caution should be the investor mantra.
Comments may be sent to Jmulraj@asiaconverge.com
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