The late plays by William Shakespeare are alternately called his “romances” or his “problem plays,” because of their ambiguity in tone, as they alternate from passages of magical realism to stark scenes that grapple with complex social issues. At times, they point the way toward the prestige TV of the early 21st century where, for instance, The Sopranos could range from broad comedy to intense violence to avant-garde dream sequences, all in one episode. It’s from the romances that we get phrases that stick with us today, like the description from The Tempest of a “sea change into something rich and strange.”
Fortune talked to BofA Research’s Head of US Equity & Quantitative Strategy, Savita Subramanian, to dig into this change, potentially to something rich and strange. It’s not quite that mystical, she said, but she still thinks it’s a big deal.
Subramanian explained that what her team has projected isn’t as exciting or dramatic as having actual wizards working at the gears of the economy. The more prosaic insight, she says, is that the combination of AI technology and lessons learned from the inflation wave of the 2020s mean that worker productivity is finally showing signs of increasing. That’s the sea change taking place.
But the official stats don’t show a complete understanding of how productivity really functions, Subramanian explained. So BofA took sales, adjusted for inflation, and then divided sales by the number of people working at S&P 500 companies, showing real sales growth versus number of people, what she called a “decent proxy” for productivity, “because if you’re productive, you are doing things more efficiently, you need less labor. And this is more labor efficiency than anything else.”
Look at what she found.
This means companies are learning to do more with less, and that is kind of magical. Companies have had to do harder work to generate earnings and keep margins healthy, often by replacing their people with processes. “A process is almost free and it’s replicable for eternity,” she said, adding that she thinks this is why the companies exercising efficiency gains have tended to outperform. It’s not only about AI displacing workers, but a fundamental shift in how business is being done.
This discussion may seem on its face to be more boring than a tempest and a wizard, she said, but there is something supernatural about the current moment. “I think people love this AI technology because it feels like sorcery,” she said, before adding, “the truth is it hasn’t really changed the world that much yet, but I don’t think it’s something to be dismissed.”
Overall, Subramanian finds the S&P 500 has shifted from its 1980s model of asset- and labor-intensive manufacturing to asset- and labor-light innovation, namely tech and health care firms. Showing her work, she calculates that the S&P 500 firms with a focus on innovation, measured through high research and development expenditures, trade at structurally higher multiples of 29x forward earnings per share. More capital-intensive manufacturers, on the other hand, trade at a 21x multiple. The current AI boom is actually a bit risky, she wrote, because the massive data center investments represent a shift from an asset-light to an asset-heavier focus.
To be sure, BofA finds that the S&P 500 is now statistically expensive on 19 out of the 20 metrics that they track, including P/E, price to book, price to cash flow, and market cap/GDP. That’s where the sea change matters, because if the shift from manufacturing to innovation is real, then valuations have to shift as well. Hence the “innovation premium” from BofA’s research.
There are other shifts afoot as well, she told Fortune. “We seem to be at least pausing on this globalization theme,” she said, citing China’s admission to the World Trade Organization in 2001 as a big driver of margin expansion, enabling cost-cutting as a huge lever to keep margins expanding. (It was also the year when worker productivity froze in its tracks.)
For example, Subramanian said it was common to see companies that knew they would miss their earnings estimates borrowing money and buying back stock to hit their targets, adding the caveat that “there are good reasons to do share buybacks and bad reasons to do share buybacks.” This all “really created a lot of bizarre behavior.”
The situation now is harder in many ways, but companies aren’t able to financially engineer their way to earnings growth, she added. Now that’s a sea change.
One final note on the Shakespearean romances, from Drew Lichtenberg: that appellation came about in the late 1700s, nearly two centuries after Shakespeare’s lifetime, with the birth of the romantic movement. The word “romantic” had previously existed, but it didn’t have its current meaning until Samuel Taylor Coleridge elevated it to mean something that connects back directly to nature and the divine genius of humanity’s self-expression. This was largely a response to the Enlightenment’s elevation of reason and logic and its ultimate achievement: the Industrial Revolution that unleashed modern capitalism on the world. A sea change, indeed.
