Partner Content by Artemis

Global equities: Negotiating the transition to a ‘new regime’

Picturing a decade of malinvestment

 

QE also resulted in malinvestment. By reducing the time value of money to zero, QE and NZIRP stretched investors’ time horizons. The beneficiaries included:

  • food-delivery platforms;
  • ride-sharing services;
  • streaming services;
  • cryptocurrencies;
  • online sub-prime consumer finance companies;
  • producers of lab-grown ‘meat’; and
  • private equity and leveraged-driven business models.

In many cases, these companies had minimal tangible assets and their shareholders were funding eye-watering operating losses.

There was a long period of underinvestment in the ‘physical economy’…

A side effect of the flood of capital being directed towards profitless growth stocks was that – in relative terms – the cost of capital for established, profitable companies in a range of ‘old-fashioned’ industries increased. The result was that, for almost a decade, we saw underinvestment in some of those companies who keep the physical economy ticking over:

  • energy companies;
  • commodity producers;
  • construction stocks;
  • food producers;
  • transportation businesses;
  • manufacturers of building materials and industrial machinery; and
  • national security (food, energy, vaccines etc).

In the case of the energy companies, the market was, in effect, dissuading them from investing in new oil fields, building new refineries or committing the capital needed to maintain and replace productive assets as they matured and degraded. Instead, it was signalling a preference for providing city dwellers with subsidised food deliveries.

CapEx in the energy sector in recent years has barely covered deprecation, allowing for little spending on new discoveries. The consequences of a long period of underinvestment by energy companies are being felt today.

‘Old fashioned’ companies are fighting back

As demand roared back after the pandemic, the capacity to meet that demand no longer existed; the sharp rise in energy and petrochemical prices provides a dramatic illustration of what happens when price-inelastic demand encounters fixed supply. The impact on energy companies’ earnings has been dramatic. Exxon’s US refineries will generate more profits for their parent company in the second quarter of this year than they did in the previous nine quarters combined. Energy companies led earnings growth in the US market during the second quarter (followed by industrials and materials). Strip out the contribution from energy stocks and earnings growth across the S&P500 would have been negative for the quarter…

And it isn’t just energy stocks – a range of ‘old fashioned’ companies are becoming far more profitable. In part, this reflects a spike in commodity prices triggered by the invasion of Ukraine. But the improved financial performance of these companies also reflects the leanness of their operating models and the relative strength of their balance sheets. In recent years, while private equity companies were bidding up the value of loss-making companies one funding round after another, miners and energy companies were paying their down debts and trimming operational fat.

Now, as central banks withdraw liquidity and credit is withdrawn, the tide is turning against companies who need steady infusions of capital merely to survive and back towards mature, profitable companies who are generating profits rather than burning cash.