How can it be that an industry that creates no tangible products is worth about 25% of the value of all equities, and represents an even higher proportion of profits?
It's a time of great innovation and development throughout the Financials sector. Myriad new financial instruments are adding stability and contributing greater efficiency to markets of all kinds, from stock markets to lending activity to basic transactions. Consumer Banking, Credit Cards, Investment Banking, Asset Management, Capital Markets, Direct Investment, Insurance, you name it—they've all undergone tremendous change in recent decades, becoming more efficient and creating more value.
It should be little wonder, then, Financials margins are very high compared to most other industries. The basic principles of capitalism suggest a gusher of increased profitability should lead to a glut of new entrants, ultimately leading to lower margins and lower compensation averages. But it hasn't happened yet. Is there something structural about the sector preventing it?
It's difficult to say for sure. However, there is one structural factor that could be causing Financials outsized growth and profitability. Simply, the amount of total wealth is increasing and no other sector benefits as greatly from it.
If people have more money they will spend some of it on products and services, but all of it will end up flowing through the financial sector in some way. If you provide a product or service in other sectors it earns you a profit once, but when a dollar of wealth is created it will continue to move around forever until destroyed by war or unwise investment. As this pile grows, Financials benefit most.
Imagine a world where no one has any savings or wealth, you would still need a food industry and a housing industry and a clothing industry and so on, but there wouldn't be much business for Financials companies. On the other hand, if everyone was a millionaire, there would be increased demand for cars and travel and lawyers, but Financials would see by far the biggest increase in business.
The Financials revolution is a product of capital markets innovation and tremendous wealth growth in the world—both great things. Long live the Revolution!
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.