Stockmarkets are about pricing, and for a long time that has mattered for western economies. Valuing businesses sets the terms on which listed companies raise capital, buy back shares, incentivise executives and allocate resources. But the concept of the market economy as the natural order of economics, will be questioned in a post-virus world. Investors may have to learn new rules.
Any challenge to long held beliefs can be hard to resolve – where emotion is involved, it takes time to accept new information. We can fail to recognise how much our framework of beliefs underpins our analyses and decisions. Investors whose careers have spanned privatisations, stockmarket deregulation, shrinking government and globalisation may see these as drivers of growth and prosperity. But, in future, the challenge will be to incorporate hard-to-price risks such as politics, tax and more government intervention.
Even before the crisis, stockmarkets were becoming a little less relevant. In the major western economies, the amount of issued stock has been shrinking as share buybacks and private equity took their toll. Along with a decline in trading volumes and research, this made some question whether share prices were still correct and reliable. Other factors included the growth of index funds, which do not themselves contribute to setting prices. The more recent boost to issued equity - from emergency refinancing by some consumer and travel businesses may not stop this trend.
Now, the relevance to the stockmarket has been dealt another blow. Clearly it was not handling well key issues like resilience and governance. As a result, in the western economies, it looks like bigger government lies ahead. Some key national priorities are never going to be dealt with well by competitive forces. The stockmarket may be left to implement ESG, with a bigger role for governance in particular. Redirection of executive incentives will be part of this. Some boards have added to the shutdown problems by handling staff and customers in brand-damaging ways.
But the stockmarket may not have the key role in resilience – it looks a lot like inefficiency in a market-driven economy and tends to be squeezed out. In recent years that has meant eliminating buffers and paying out anything that looks like unnecessary capital. Some businesses have been leveraged-up into a fragile state. That means an overhaul of tax systems that encourage borrowing.
Investment professionals must expect a change in the order of things. We can expect bigger government to deliver the central planning needed, reversing the trend of the last 40 years. It may not only mean more government direction in the national interest, but a recognition that paying taxes is a key part of being able to access a national safety-net. The emphasis is likely to be on how much a business is genuinely part of the national economy. Multi-nationals with clever tax optimisation in tax-havens and with questionable transfer pricing, could find it much harder win political support. And where the national interest is itself confused - as in the European Union structure – it may be much harder to target business support. Investors will need to think more carefully about who ultimately sponsors a corporate entity.
The speed of the stockmarket bounce may conceal the change that lies ahead. Businesses will shorten supply chains and move more onto the cloud. There will be lasting implications for city-centre office space, business travel and flexible working. But the more subtle changes may involve the emergence of national champions, takeover protection and more public questioning of business purpose and practice. Investors are likely to favour businesses that align with these new trends.
A version of this article was published on Citywire on 21/05/2020.