We are continuously hearing about “The Great Resignation,” but I don’t think there is enough talk about “The Great Substitution.”
You can find substitution occurring everywhere — and this affects your life and your finances. For example, during the pandemic, many of us substituted streaming services for cable. But that is just an obvious substitution.
It is natural that people pursue higher-paying jobs, and that’s especially true at the lower economic rungs where a job may not be a career. If Amazon can pay $20 an hour for an entry-level position, they will draw fromplaces that pay less.
Hospitality generally offers lower-paying jobs that cannot pay those rates, so one of the first great substitutions is service in the hospitality industry. Finding housekeeping is more difficult for hotels, so daily room cleaning is a dirty concept. Finding staffing for restaurants is challenging, so we are seeing reduced hours and service.
But reduced hours and poor service push consumers to substitute going out with staying in. As non-cooks become more comfortable making meals, this shift means that they can create an enjoyable experience at home allowing them to more easily pay for the rising costs of food. Diminishing hotel service makes substituting VRBO or Airbnb a better alternative — at least you can spread out in the vacation place.
The ability to work from anywhere creates a real estate substitution. No, this is not a treatise on the decline of the cities, this is a simple statement: If some people don’t need to live near their office, they won’t. We can’t tell yet how permanent a substitution this will represent, but there is certainly appeal for someone who has a job that can be performed in a place with high-speed internet and lots of nature for significantly lower lifestyle costs.
Not only can people work from a variety of places, but we don’t need as many people to be working. Market-dominant technology companies are far more scalable than current manufacturing companies because they don’t need as many workers to fuel their growth. Technology is a substitute for people (and robots are only the beginning).
Technology is also a substitute for education. Google’s Certificate Program for some is a viable alternative to trade schools or college. While it may not be the same experience that someone gets from obtaining a two- or four-year degree, it still will result in solid employment opportunities. In this way, advancements in technology substitute inflation for deflation.
The great substitution has occurred in stocks as well. We have a winner-take-all stock market in which companies like Amazon, Apple and Google have an uncanny ability to increase sales and profit margins as consumers are locked into their product. As their margins expand, their stock price increases, allowing them to pick up companies for a pittance of their market capitalization. A $1 trillion company buying a $20 billion company is little more than a rounding error. These mega-stocks end up substituting for smaller companies by absorbing them.
But there eventually is also a substitution in market dominance of stocks simply because their story substituted for their fundamentals. This means that great companies can still be overpriced, and companies that have the best stories often go to the pricing extremes. These eventually recalibrate as investors substitute in less expensive companies.
Many of the Nifty Fifty stocks survived their market crash and generated solid returns because they were strong businesses. Some did not. Regression to the mean in investing tends to be as powerful as gravity. This doesn’t mean all stocks produce equal returns, but that an ugly-duckling, unloved group of stocks held for a couple of years can develop into swans. Mean regression works best in asset classes, not individual stocks. Large stocks, small stocks, growth stocks, value stocks and international stocks over time have similar returns. That is why rebalancing among asset classes (an act of substitution) is the best way to get more predictable returns over time.
Be proactive in making changes so that you can be creative in the substitutions you wish to make.
Ross Levin (firstname.lastname@example.org) is a founding principal and president of Accredited Investors Inc., Edina.