For the last few years there’s been an idea doing the rounds in free market circles that capitalism is faltering, but not for the reasons that many on the left would have you believe. Variant Perceptions Jonathan Tepper has been especially cogent in arguing that capitalism has become too concentrated in a few big firms, verging into crony capitalism as these leviathans use their superior scale to buy regulatory influence. I think it’s a very powerful argument and one that cuts to the heart of the current thinking of regulatory policy – rather than using a narrow test of consumer impediment, we should adopt a more expansive interpretation that looks at sheer market power. Tepper’s Myth of Capitalism book makes this argument eloquently – his book is available here.

My suspicion is that the Covid 19 crisis will only make this problem much, much worse. Leviathan, mega cap businesses, especially those listed in the stockmarket have long had much easier access to wholesale markets where lending rates were already low. The viral crisis has simply intensified this scale advantage. In addition many, though not all, mega large caps have more available cash on their balance sheet which would allow them to survive longer in the coming crunch as the first phase of the virus mutates into a longer battle to keep infection rates down.  It’s also a sad truth that its very easy for the boss of a mega cap to pick up the phone to the BoE or the Fed and ask about a line of credit while the boss of a small or mid cap probably wouldn’t even get past the switchboard, assuming they could find the right telephone number. Last but by no means least, its also obvious that leviathan mega caps will be busy using their lobbying power with big government to protect their interests. Smaller businesses will be left scrapping for help form industry associations.

Another argument in favour of concentrated capitalism emerged in a comment this week from Ben Luk, senior multi-asset strategist at State Street Global Markets. Stockmarkets are increasingly rewarding the very biggest businesses with better share prices. His observation is that although the markets overall are still down 17% year to date, once you dig around in the numbers you discover that the losses have varied markedly between constituents, with

mega-cap stocks (what he defines as the top five stocks across key markets, which makes up to 20 percent of the index) “showing little impact from Covid-19”.

“In fact, the top five emerging market companies contributed less than five percent of the index’s loss, relative to its 23 percent weight within the index. This number becomes more extreme for European corporates at one percent and even more staggering for the US, in which the top five actually recorded a gain but the rest of the index was responsible for 100 percent of the entire loss. Whilst most have suffered due to the virus, the virus has also solidified the mega caps!”

Is COVID-19 Solidifying the Mega Caps?

Source: State Street Global Markets, MSCI, Bloomberg

The ever-slower boat to China

Regular readers will know that I quite like the look of specialist shipping fund Tufton Oceanic, which boasts 16 ships on lease. I’ve already commented that investors appear to have a decent margin of safety with a yield of around 8.2% and a discount of 12.3% against NAV.

A note out this week from house brokers N+1 Singer also give us a little more colour on the funds short term risk profile. According to the note “Vessels which have charters expiring in the next six months represent only c16% of NAV as at 31 Mar 20. The manager expects to re-charter these vessels as their current charters expire at lower shorter term charter rates, before renegotiating higher longer term charters in due course. Elsewhere the remaining vessels are chartered on much longer terms with the average unexpired charter being 2.8 years”.

But digging around in the note, I came across a fascinating side debate. The International Maritime Organisation, the IMO, has mandated that from 1st January 2020, the limit for sulphur content in shipping fuel is to be reduced to 0.5% unless the ship is retrofitted with an exhaust gas cleaning system or “scrubber”.

As a result the “majority of the world shipping fleet has switched to very low sulphur fuel oil (VLSFO) to achieve compliance. However, this switch has driven up the cost of VLSFO to $75 per ton (c65%) premium to traditional high sulphur fuel oil (HSFO) in the futures market. Recent data confirms that ships have already started responding to the higher fuel costs by reducing operating speeds.” [ my emphasis added]

According to the N+1 report “the average speed of the global fleet decreased by about 2% during Q4 2019 as this fuel switch began. The average speed of the world fleet at the end of 2019 was at seven-year lows. Tufton estimate that a 10% reduction in the fleet speed would result in a 5-7% reduction in available capacity, therefore supporting profitability. While the speed reduction from higher fuel cost may be partially reversed, a more permanent reduction in fleet speed is expected due to new short-term measures from the IMO, which are expected to be introduced in 2023 to reduce carbon emissions further.

The IMO has declared an ambition to decrease shipping carbon emissions by 50% from 2008 baseline by 2050. Speed reduction is one effective means to reduce emissions and will be part of the short-term measures mandated by the IMO towards the goal of longer-term emission reduction. Changing design specifications and a switch to low carbon fuel adds to uncertainty and delays on new ship orders; this will lead to a reduced supply of ships in the market over the coming years. Tufton believes that this long-term trend combined with speed reduction over the medium term will support market rates as well as capital values for secondhand vessels”.