Investors should bet on smaller nimbler companies and countries
In a time of turmoil and conflict, the best strategy is to go south and nimble
Rana Foroohar
Monopoly power is and remains a huge problem in the global economy. But the news of the last week has me wondering whether we have reached what might be called “Peak Big”: a new limit to the advantages of size.
If you think about recent news stories, from Donald Trump’s China tariffs, to the Facebook privacy scandal, to recent market volatility, the common thread is that all things large are under threat.
Big countries and regions, such as the US, China and the EU, are most at risk from a trade war. Should there be more extensive tariffs, companies with the biggest market capitalisation would most likely be hit hardest.
Manufacturing brands — Boeing, Caterpillar, 3M — have already suffered large share price dips and the Dow Jones Industrial Average, which includes the biggest stocks, fell 6 per cent on the Trump tariff news.
Meanwhile, the biggest US tech companies are squarely in the sights of regulators on both sides of the Atlantic. Even big corporate pay packages are being challenged by US rules around wage disclosures that will make the largesse of executive salaries ever more visible.
The assets that seem undervalued and safer are all smaller things. Southeast Asian “countries, as well as Southern Europe and parts of Latin America have lots of slack relative in particular to the US, but also core Europe and even China”, says Jay Pelosky, head of the investment advisory firm Pelosky Global Strategies. “They have more room for growth, profit expansion, investment, and a lot more political breathing space.”
Mr Pelosky, who is based in New York, believes regionalism is the new globalism and espouses a “tri-polar” world theory, in which the Americas, Europe and Asia go their own ways and the south of each region in particular prospers.
He has a good point. Start with the geopolitics. Much of Latin America is coming out of decades of populism and protectionism while the rest of the world seems to be plunging headlong into it.
While the US is at the end of a recovery cycle, many analysts believe Latin American markets have plenty of room to run.
The same goes in Europe, where the German DAX and the FTSE 100 are down 7 and 9 per cent since the start of the year. If you assume the EU will hold together, then you also have to assume that most of the potential growth upside is in the periphery, rather than the core (with the exception of France). Indeed, Italy’s main index is one of the few in the EU that is up for 2018. It seems that many in the market buy this story, with bond yields shrinking in countries such as Spain and Portugal.
Meanwhile, if the US and China really do end up engaging in a full-blown trade war, it may be the smaller Southeast Asian nations that will benefit, since they will continue to be open for business with both. The Association of South East Asian Nations could become an alternative supply chain and preferred trading partner for either region.
At the company level, smaller also seems smarter. Small-cap stocks are still a good buy even as the S&P 500 valuations seem high, as compared by price-to-sales ratios.
Any coming regulation in areas such as tech, will probably target big players not small and mid-sized ones. Even in China, where the largest tech firms do not have to worry about regulation in the same way, it is the big companies that investors have soured on — Chinese tech group Tencent lost $51bn off its market value last week after announcing margins would shrink to fund spending on content and technology.
It may be that Big Tech companies, like big banks, have simply become too sprawling for their own good. Smaller, more localised players will probably also avoid the worst effects of tariffs.
“In a war, it’s all about destroying symbols,” says Peter Atwater, head of the research group Financial Insyghts. “Successfully bring down the share prices of even the top 10 firms, and you’ve hurt the US financial system.”
Aside from being a less visible target for protectionism, small firms with lower debt levels are better positioned to cope with rising interest rates. Research group Strategas notes that small-cap stocks are the only asset class that has outperformed inflation in every decade from the 1930s onwards.
That may be in part because they are not overpaying their top executives like many of the largest US companies. A recent survey of US public companies by the executive compensation firm Equilar found that the median ratio of a chief executive’s pay to his or her median worker was 140 to one.
But for companies worth more than $15bn, the median ratio was 263 to one. Starting this year, the US Securities and Exchange Commission will require large US-based companies to disclose that ratio. Politicians may decide to make the most of those numbers in a midterm election year.
Of course, there are any number of events that would hurt large and small companies alike — from a global trade war to a nuclear conflict. Yet it is worth remembering that, in times of great change, chaos and conflict, it is often smaller, nimbler countries and companies that do well. This may be a time to bet on David. Goliath is overvalued.
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