15th June, 2017
Way back in 1981, the writer William Gibson remarked “The future is already here – it’s just not very evenly distributed.” Investors tend to think of stock markets as predictive, but they are mostly the result of economic activity in the past.
The largest sectors of a stock market are those which have done well in the past. They are made up of companies which have consistently made large profits and raised large amounts of capital. Investors have come to expect that these companies will keep making profits and paying dividends. But most companies don’t survive for long.
To demonstrate how much stock market indices change over time, we have used a chart from the Credit Suisse Global Investment Returns Yearbook 2017, which is a highly authoritative document on long term returns. It is based on research published in 2002 by three academics, Elroy Dimson, Paul Marsh and Mike Staunton (“DMS”), and progressively updated since then. DMS assembled investment return data from 1900 onwards for as many countries as they could, checking and cleaning all the data in order to ensure that it was accurate and consistent. Credit Suisse now fund and publish the annual update of this data, which now covers 23 countries.
Chart 2 below shows the industry composition of the USA and UK stock markets in 1900 and 2016. In both cases, the railway companies made up the bulk of the market’s value. Banks and mines and other familiar industries appear, but are relatively small.
The railways were important because they were the big growth industry of the nineteenth century. In 1800, the transport of goods and people relied on manpower, horse power and wind power. The modification of James Watt’s steam-driven engines to drive ships started a revolution in transport which led to the first railway engines in the 1820s. Unprecedented amounts of capital were raised in the UK in the 1830s to build railways, and railway fever spread around the world. By 1900 steamships and railways had opened up vast regions of the world. For example, the invention of refrigerated shipping allowed Australia, New Zealand, the USA and Argentina to export meat to Europe, setting in train a collapse in the value of European agricultural land. Over the course of the nineteenth century, the per kilometre cost of transporting people and goods fell by 90%.
In 1900, the railways had only one way to go – down. By the 1970s all the major rail groups in developed countries had gone broke or been nationalized, because the advent of the automobile had slashed their profits. The stock markets were dominated by automobile companies and oil companies.
So when we see tech companies like Apple, Amazon, Facebook, and Google rising to the top of the US share market, we know that they are there because of how fast they have grown in the last three decades – not because they will be important for the next three decades.
What we want to emphasize is that the big companies which we see around us at present are the result of long term trends in economies and stock markets. These trends may continue, or they may reverse. Monitoring them and predicting their direction is fundamental to Arminius’ business, because it is one of the foundations of our investment performance.