Wednesday, August 21, 2024

Sector performance comes and goes - Prepare for mean revisions

 



Markets mean-revert. Sectors also mean-revert. The importance of a given sector within the overall equity markets will change through time. The revisions may take decades, yet the importance of a given sector will rise and fall with new technology, sentiment, and competition. Fromm Schumpeter, creative destruction is an essential part of capitalism. It can come from competition, but it also comes from changing tastes and demand both for a product and for expectations of future earnings. 

The extremes in computer software, internet services, and computer components will not last, yet a forecast is hard to make. Even passive investors will be impacted by the changing weights of sector capitalization. The euphoria of today will be hard to sustain for long periods when discounting cash flows.

The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as US Steel illustrate the same process of industrial mutation-if I may use that biological term-that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. 

Joseph Schumpeter, Capitalism, Socialism and Democracy, 1942; Third Edition, 2014. Part II, Chapter VII, pg.83

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