For Profit Growth, Corporate Size Does Matter

Jack Ablin Market Commentary

The S&P 500 has surged nearly 30 per cent in 2019 as investors celebrate the tenth year of the expansion. Optimism is running high with the unemployment rate at its lowest level in 50 years. Yet, behind the jubilance, corporate profits, as gauged by the Federal Reserve’s National Income data series, are sliding. Since peaking in 2014, non-financial corporate profits before tax have contracted at a 5.2 per cent annualized rate. Profits are down 6.9 per cent over the last four quarters through September. Meanwhile, however, profits reported by S&P companies have expanded at an annualized 6.2 per cent over the last five years. What gives?

A recent report in The Wall Street Journal suggests that large, public companies are better at dodging taxes than their smaller, private counterparts. The article also points out that S&P 500 companies are generally more successful than the average American business. While these are valid arguments, the biggest factor influencing the profit gap is the growing concentration of industries among fewer and fewer powerful companies. According to a recent Bloomberg study of Bureau of Economic Analysis data, nearly 60 per cent of output of the information sector is derived from a few dozen counties concentrated in Northern California and Seattle, Washington. A similar trend has emerged in the arts & entertainment space, where Los Angeles accounts for nearly 40 per cent of sector output. Industry concentration has given the largest companies a competitive advantage, and this cohort has enjoyed higher profit margins.

Since the 1990s growth in American output, wages and productivity have slowed, as has inequality, both in wages, market share and profits. According to a recent report in The Economist, between 1987 and 2016 the share of employment among firms of 5,000 employees or greater rose from 28 per cent to 34 per cent. Additionally, from 1997 to 2012 the average share of revenues migrating to the top four firms in each of 900 economic sector groups grew from 26 per cent to 32 per cent.

Lackluster antitrust enforcement has enabled anticompetitive practices to flourish in myriad industries, most notably technology and health care. This has led to a capital investment shortfall and lower-than-expected productivity and wage growth. Over the last five years, productivity expanded a tepid 1 per cent annually, following a productivity downtrend that began in 2004.

US technology giants have spent the last two decades gobbling up potential competitors. America’s lawmakers face a quandary: if they rein in these superstars to address domestic imbalances, they run the risk of crippling their global competitiveness. Addressing the consolidation in health care, however, should be unambiguous in our view. The US health care system is costly and inefficient: Americans pay double the amount per capita for health care vs our developed country trading partners. Congress needs to level the playing field and invite more competition. The result would be increased investment, higher productivity and stronger wage growth. Although companies like Google and Facebook are at risk of increased regulatory oversight, we believe the health care sector is probably most exposed to increased regulatory scrutiny, especially in an election year.