Productivity growth is one the critical economic variables for investors to watch. For the economy as a whole, it is a key driver of GDP growth, and therefore of broad earnings growth.
But within particular sectors and industries, and within particular companies, it drives margin improvements in a way that can make those sectors, industries, and companies standouts compared to peers and the broader economy. Productivity growth trends benefit both the adopters of productivity-enhancing technologies and practices, and the creators and purveyors of those technologies and practices.
For any investor who wants to do more than passively follow a stock-market index, then, productivity trends are key. And to accurately evaluate the future prospects of individual companies, investors must understand how they are situated to benefit from those trends — or not.
What the Pandemic Has Done
Rising concern about new covid variants and potential renewed lockdowns are creating volatility as the market runs into poor seasonals, peaking growth and liquidity, inflation worries, and geopolitical strains. In such periods it is all the more important to stay focused on signal rather than noise. It’s important to consider that some of the lasting effects of the pandemic will be positive, and one of those is a likely long-term increase in trend productivity growth for the U.S. economy — with even larger benefits within specific sectors and industries.
Those benefits will be accruing long past the market’s current volatility. Operating margins are tracking 1.8% above pre-covid levels for U.S. nonfinancial services firms, and in tech services and professional services, those improvements are even more marked.
Source: Goldman Sachs Research
Right now, economy-wide,the positive technological and business process changes created by the pandemic are still being masked by the its after-effects. (Most of those after-effects are negative, but a few are positive, such as a mix shift towards more efficient industries as labor-intensive, lower-productivity industries, such as hospitality, shrank in the overall economic mix during the lockdowns.)
Pre-pandemic productivity growth economy-wide was at a long-term trend of 1.4% annually. Evidence suggests that when lingering pandemic effects are normalized — as base effects are lapped, the economy fully reopens, employment normalizes, and the sector and industry mix rebalances — the trend growth rate of productivity could double from its recent long-term trend. (And we note that even before that normalization, there are many companies experiencing strong benefits.)
Source: Goldman Sachs Research
Where the Benefits Come From
The observed post-pandemic productivity increase has several sources. One, noted above, is likely to be largely transitory — a temporary shift away from labor-intensive service industries during lockdowns. Some of that will remain; much will return to the pre-pandemic normal.
Much more significant are technological changes. We’ve noted in letters throughout the pandemic that those industries ripe for digitization would be primary beneficiaries of pandemic-era changes, and that those changes would endure, shifting digitization trends onto a new trajectory. (Here, we discussed e-commerce and fintech particularly.)
Any companies and industries suited for digitization which successfully embraced it during the pandemic are experiencing the benefits in worker productivity and margin improvements. As seen in the chart below, those include particularly IT services, wholesale businesses (though some of these are adversely impacted by supply chain disruption), professional services, retail, and many financial areas (particularly fintech disruptors).
Source: Goldman Sachs Research
It is important in studying the chart above to realize that it presents industry-level results. These will conceal considerable variation in the capacity of individual companies to embrace and implement digitization. PayPal [PYPL] is not Wells Fargo [WFC]. Sometimes large incumbents can move rapidly — as Starbucks [SBUX] did in its quick pandemic expansion of curbside pickup and contactless payments. Sometimes incumbents are slower and less adaptive. Only analysis of individual companies can identify this.
In services, anyone who could quickly move to remote workplaces and deliver their services efficiently from them are reaping the rewards. They will continue to do so even as workers return to the office — since incrementally, many workplaces are permitting permanent hybrid work-from-home solutions. That may not eliminate their need for office space, but it will reduce it, as well as many other costs.
The presence of durable goods manufacturing in the chart above is noteworthy, we believe. This industry is also a major beneficiary of digitization. It was front and center in the pandemic as lockdowns, personnel restrictions, and social distancing forced the rethinking, streamlining, and digitizing of management and manufacturing processes. Successful companies in this industry are intelligently rethinking and automating procurement and inventory management during the current period of disruption. We have already heard anecdotally from some manufacturing operating officers that effective systems put in place early last year have been able to obviate some of the supply disruptions and price spikes experienced by less nimble peers.
Investment implications: Earnings season is going to be interesting. Merely having earnings rising off a low pandemic base will likely not be enough to excite market participants, particularly with the confluence of seasonal and other influences currently at work. Pay close attention to operating margins and expected rates of revenue increase for the second half of 2021 when listening to the conference calls of companies of interest; though there is a lot of confounding noise, particularly with labor and materials costs, this can help you discern whether a company is a likely beneficiary of the post-pandemic acceleration in productivity growth.
