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Steve Jobs wasn’t accustomed to hearing “no.” But that was the answer from Paul Otellini, CEO of Intel.

It was 2006, and Intel, the global king of computer chips, was bringing in record revenue and profits by dominating the kinds of chips in hottest demand—for personal computers and data centers. Now Jobs wanted Intel to make a different type of chip for a product that didn’t even exist, which would be called the iPhone.

Otellini knew chips for phones and tablets were the next big thing, but Intel had to devote substantial capital and its best minds to the fabulously profitable business it already possessed. Besides, “no one knew what the iPhone would do,” he told The Atlantic seven years later, just before he stepped down as CEO. “There was a chip that they were interested in, that they wanted to pay a certain price for and not a nickel more, and that price was below our forecasted cost. I couldn’t see it.”

Otellini, who died in 2017, was a highly successful CEO by many measures. But if that decision had gone the other way, Intel might have become a chip titan of the post-PC era. Instead, it gave up on phone chips in 2016 after losing billions trying to become a significant player. As he left the company, Otellini seemed to grasp the magnitude of his decision: “The world would have been a lot different if we’d done it.”

Meantime, some 800 miles north, in Seattle, Microsoft was struggling to find its role in a tech world dominated by the internet, mobile devices, social media, and search. Investors were not impressed by its efforts. No one could have foreseen that years later, a few key decisions would set the company up as an AI powerhouse and send its stock soaring.

There was a time not so long ago that Microsoft and Intel were both atop the tech world. They were neither competitors nor significant customers of each other, but what New York University’s Adam Brandenburger and Yale’s Barry Nalebuff deemed “complementors.” Microsoft built its hugely profitable Windows operating system over the years to work on computers that used Intel’s chips, and Intel designed new chips to run Windows (hence “Wintel”). The system fueled the leading tech product of the 1990s, the personal computer. Microsoft’s Bill Gates became a celebrity wonk billionaire, and Intel CEO Andy Grove was Time’s 1997 Man of the Year.

Since then their paths have diverged sharply. Microsoft in 2000 was the world’s most valuable company, and after losing that distinction for many years, it’s No. 1 again. Intel was the world’s sixth most valuable company in 2000 and the largest maker of semiconductors; today it’s No. 69 by value and No. 2 in semiconductors by revenue, far behind No. 1 TSMC (and in some years also behind Samsung).

A Fortune 500 CEO makes thousands of decisions in a career, a few of which will turn out to be momentous. What’s easy to explain in hindsight—that Microsoft would be at the forefront of AI, that Google would become a behemoth, that Blockbuster would fade into obscurity—is never preordained. Often the fateful decisions are identifiable only in retrospect. Nothing more vividly illustrates this than the parallel stories of Microsoft and Intel. The case study of what went right and wrong at those two giant corporations offers a master class in business strategy not just for today’s front-runners at the likes of Google, Open AI, Amazon, and elsewhere—but also for any Fortune 500 leader hoping to survive and thrive in the coming decade.

The two companies were founded a mere seven years apart. Intel’s founders in 1968 included Robert Noyce, coinventor of the computer chip, and Gordon Moore, who had written the seminal article observing that the number of transistors on a chip doubled every year, which he later revised to two years—Moore’s law, as others later called it. Andy Grove was employee No. 3. All three are still regarded as giants of the industry.

Bill Gates famously dropped out of Harvard to cofound Microsoft with Paul Allen, a childhood friend. They were excited by the prospects of creating software for a new concept, the personal computer, also called a microcomputer. They launched Microsoft in 1975.

The two companies’ paths crossed when IBM decided in 1980 to produce a PC and wanted to move fast by using existing chips and an existing operating system developed by others. It chose Intel’s chips and Microsoft’s operating system, profoundly transforming both companies and the people who ran them. IBM’s size and prestige made its design the industry standard, so that virtually all PCs, regardless of manufacturer, used the same Intel chips and Microsoft operating system for decades thereafter. As PCs swept America and the world, Intel and Microsoft became symbols of technology triumphant, glamour, success, and the historic bull market of 1982 to 2000.

Then everything changed.

In October, 2000, Fortune ran an article with an illustration depicting Gates and Grove as monumental Egyptian sphinxes. The headline: “Their Reign Is Over.”

The reasoning: “Gates and Grove attained hegemony by exploiting a couple of key choke points in computer architecture—the operating system and the PC microprocessor,” the article explained. “But in the new, more diverse IT world wired together by universal internet protocols, there are no such obvious choke points to commandeer.”

Thus began a multiyear identity crisis for both companies. Intel’s PC chips and Microsoft’s PC operating system and applications remained bountifully profitable businesses, but both companies and their investors knew those were not the future. So what was? And who would lead this new era?

In January of 2000, Gates stepped down as CEO after 25 years, and Steve Ballmer, Microsoft’s president and a college friend of Gates, took his place; Gates remained chairman. Two days later, Microsoft’s stock rocket ran out of fuel. On that day the company’s market value hit $619 billion, a level it would not reach again for almost 18 years.

Grove was no longer Intel’s CEO in 2000, having handed the job to Craig Barrett, a longtime company executive, in 1998. But as Intel’s visionary and most successful CEO, Grove remained an important presence as chairman of the board. His health was becoming an issue; he had been diagnosed with prostate cancer in 1995, and in 2000 he was diagnosed with Parkinson’s disease. Intel’s stock roared until August, when the company’s market value peaked at $500 billion. It has never reached that level since.

But most significantly, 2000 was the year that the internet began to seem like it just might make Wintel irrelevant.

At Intel, Barrett responded with acquisitions, many of which were in telecommunications and wireless technology. In concept, that made great sense. Cell phones were going mainstream, and they required new kinds of chips. “Craig tried to very aggressively diversify Intel by acquiring his way into new businesses,” says David Yoffie, a Harvard Business School professor who was on Intel’s board of directors at the time. “I would say that was not his skill set, and 100% of those acquisitions failed. We spent $12 billion, and the return was zero or negative.”

In the lean years after the dotcom balloon popped, Barrett continued to invest billions in new chip factories, known as fabs, and in new production technologies, so Intel would be well positioned when demand rebounded. That is a hint to one of the most important lessons of the Wintel saga and beyond: Protecting the incumbent business, even in a time of transition, is almost impossible to resist. That course usually sounds reasonable, but it holds the danger of starving the company’s future. As the great management writer Peter Drucker said: “If leaders are unable to slough off yesterday, to abandon yesterday, they simply will not be able to create tomorrow.”

At Microsoft in the 2000s, “it was not at all obvious what would happen with the shape and volume of PCs, with operating system margins, or the future of applications like Word or Excel,” says Ray Ozzie, a top-level Microsoft executive from 2005 to 2010. “There was significant internal debate at Microsoft and in the industry on whether, in the future, the PC was dead, or if it would continue to grow and thrive.” Maybe Word, Excel, and those other applications that resided on your hard drive would move to the internet, like Google Docs, introduced in early 2006. In that case Microsoft would need a new business model. Should it develop one? Some executives thought so. But no one knew for sure.

During this period, Microsoft was hardly a model of corporate innovation, and succumbed to what often happens when successful companies are disrupted. Ozzie explains: “When you are rolling in resources and there are multiple existential threats, the most natural action to protect the business is to create parallel efforts. It’s more difficult to make a hard opinionated choice and go all in. Unfortunately, by creating parallel efforts, you create silos and internal conflict, which can be dysfunctional.”

As competing teams fought for primacy, Microsoft missed the two most supremely profitable businesses since the PC era: search and cell phones. Those misses were not fatal because Microsoft still had two reliable, highly profitable businesses: the Windows operating system and the Office suite of apps. But in Drucker’s terms, those were yesterday businesses. Investors didn’t see substantial tomorrow businesses, which is why the stock price went essentially nowhere for years. Missing search and cell phones didn’t threaten Microsoft’s existence, but it threatened Microsoft’s relevance and importance in a changing world, which could eventually damage the company’s appeal among investors and the world’s best employees. The reasons for those crucial misses are instructive.

In 2000 Google was an insignificant internet search startup with no clear business model, but it had an inkling that selling advertising could be profitable. We know how that turned out: Google’s 2023 ad revenue was $238 billion. The model was entirely foreign to Microsoft, which made tons of money by creating software and selling it at high prices. Charging users nothing? Selling ads? Microsoft had never run a business at all like Google’s. By the time Google’s model had proved itself, Microsoft was hopelessly far behind. Today its Bing search engine has a 3% market share across all platforms worldwide, says the StatCounter web-traffic analysis firm. Google’s share is 92%.

Microsoft’s failure in cell phones was, in a large sense, similar—the company didn’t fully grasp the structure of the business until it was too late. The company assumed the cell phone industry would develop much like the PC industry, in which sellers like Dell combined Intel’s chips and Microsoft’s software in a final product. But Apple’s starkly different iPhone business model, in which it designs its own chips and writes its own software, was an enormous hit. The other big winner in the industry, Google’s Android smartphone operating system, likewise ignored the PC model. Instead of selling its operating system, Google gives it away to phone makers like Samsung and Motorola. Google makes money by putting its search engine on every phone and by charging app makers a fee when users buy apps.

Bill Gates acknowledges that Microsoft’s miss in cell phones was life-changing for the company. Looking back on his career in 2020, he said: “It’s the biggest mistake I made in terms of something that was clearly within our skill set.”

Intel also lost the mammoth cell phone opportunity, and in a similar way. It couldn’t adapt. Intel understood the opportunity and was supplying chips for the highly popular BlackBerry phone in the early 2000s. The trouble was, Intel hadn’t designed the chips. They were designed by Arm, a British firm that designs chips but doesn’t manufacture them. Arm had developed a chip architecture that used less power than other chips, a critical feature in a cell phone. Intel was manufacturing the chips and paying a royalty to Arm.

Understandably, Intel preferred to make phone chips with its own architecture, known as x86. Paul Otellini decided to stop making Arm chips and to create an x86 chip for cell phones—in retrospect, “a major strategic error,” says Yoffie. “The plan was that we would have a competitive product within a year, and we ended up not having a competitive product within a decade,” he recalls. “It wasn’t that we missed it. It was that we screwed it up.”

Just as 2000 was a turning point for Intel and Microsoft, so was 2013. Broadly they were in the same fix: still raking in money from the businesses that made them great; getting into the next big opportunities too late or unsuccessfully; groping for a megatrend they could dominate. Their stock prices had more or less flatlined for at least a decade. Then, in May 2013, Paul Otellini stepped down as Intel’s CEO. In August, Steve Ballmer announced he would step down as Microsoft’s CEO.

Succession is the board of directors’ No. 1 job, more important than all its other jobs combined. The stakes are always high. How the Intel and Microsoft boards handled their successions, nine months apart, largely explains why the two companies’ storylines have diverged so dramatically.

Under Otellini’s successor, Brian Krzanich, Intel kept missing new-chip deadlines—ironically failing to keep up with Moore’s law even as competitors did so—and lost market share. The company gave up on smartphone chips. After five years as CEO, Krzanich resigned abruptly when an investigation found he had had a consensual relationship with an employee. CFO Bob Swan stepped in as CEO, and the production troubles continued until, by 2021, for the first time in Intel’s existence, its chips were two generations behind competitors’. Those competitors were Taiwan’s TSMC and South Korea’s Samsung.

In crisis mode, Intel’s board brought back Pat Gelsinger, an engineer who had spent 30 years at Intel before leaving for 11 years to be a high-level executive at EMC and then CEO of VMware. As Intel’s CEO he has announced an extraordinarily ambitious and expensive plan to reclaim the company’s stature as the world leader in chip technology.

Microsoft’s board spent almost six months finding Ballmer’s successor under worldwide scrutiny. At least 17 candidates were publicly speculated upon. British and Las Vegas bookies offered odds on the eventual winner; Satya Nadella, who recently marked 10 years as CEO, was a 14-to-1 long shot.

Nadella has arguably been the best corporate succession choice, regardless of industry, in years or perhaps decades. Under his leadership the stock finally broke out of its 14-year trading range and shot upward, rising over 1,000%. Microsoft again became the world’s most valuable company, recently worth $3.1 trillion. Gelsinger, with just over three years in the job, can’t be fully evaluated; industry experts wonder if he’ll be Intel’s Nadella. But both CEOs offer useful examples of how to move a company from the past to the future.

Nadella orchestrated Microsoft’s dramatic turnaround by taking an outsider’s look at the company and making big changes with little drama. He began by making Office apps (Word, Excel) compatible with Apple iPhones and iPads—heresy at Microsoft, which regarded Apple as an archenemy. But Nadella realized the two companies competed very little, and why not let millions more people rely on Office apps? The move sent a message to the company and the world: The Microsoft culture’s endemic arrogance would be dialed down considerably. Interoperating with other companies could now be okay.

That was largely a new business model at the company, with many more to follow. For example, Nadella bought LinkedIn, a player in social media, which Microsoft had entirely missed, and later bought GitHub, a repository of open-source code, which Microsoft had previously despised. Both deals and several others have been standout successes.

More broadly, Nadella brought a new leadership style for a new environment. In a company known for vicious infighting that could paralyze action, he settled long-running debates over major projects. For example, in 2016 he sold the Nokia cell phone business that Microsoft had bought a year before he became CEO, acknowledging that the company had lost the battle for phones. “People don’t quite grok why things have blossomed under Satya,” says a former executive. “His superpower is to make a choice, eliminate conflict, and let the business blossom.”

At Intel, Gelsinger also introduced culture-defying changes. The company had risen to dominance by designing leading-edge chips and manufacturing them with industry-leading skill. Amid that intense pride, the idea of creating a separate foundry business—manufacturing chips designed by others—was anathema. Yet under Gelsinger, Intel has created a new foundry business while also relying more on other foundries, including TSMC, the world’s largest chipmaker, for some of its own chips—a double shock to the culture.

Getting a long-established company with a titanium-strength culture to adopt seemingly strange business models as Nadella and Gelsinger did can be painfully hard. Often only a new CEO can bring the openness necessary to make it happen. The same problem arises when a company needs to update its corporate strategy. Microsoft had been seeking and debating the next big thing for years, but Nadella saw that the company didn’t need to find a potentially huge new future-facing business. It already had one: Azure, its cloud computing service. Amazon Web Services was and is the industry leader, but Azure has grown to a strong No. 2 because Nadella has given it abundant capital and some of the company’s brightest workers. He also made an unorthodox investment in OpenAI, creator of ChatGPT, commiting $13 billion to the company starting before it was famous. Now Azure offers its customers OpenAI technology. In Drucker’s terms, it’s a big, thriving tomorrow business.

Gelsinger changed Intel’s strategy even more radically. He bet heavily and successfully on billions of dollars from the U.S. government. Via the CHIPS and Science Act, Intel could receive up to $44 billion in aid for new U.S. chip factories the company is building in coming years. “As I like to joke, no one has spent more shoe leather on the CHIPS Act than yours truly,” he tells Fortune. “I saw an awful lot of senators, House members, caucuses in the different states. It’s a lot to bring it across the line.”

A key insight is that for a major company with a history of success, like Microsoft and Intel, moving beyond an outmoded strategy and fully embracing a new one is traumatically difficult and sometimes impossible. For years both companies tried and failed to do it. A related insight: Doing it is easier for Nadella and Gelsinger because they have the advantage of being “insider outsiders,” leaders with deep knowledge of their organization but without heavy investment in its strategy; Nadella was working on Azure, not the Windows operating system or Office apps, long before he became CEO, and Gelsinger’s 11-year absence from Intel gave him license to rethink everything.

A larger lesson is that, in the stories of these two great companies, succession is the most important factor. Considering that Microsoft on the whole has fared better than Intel over the past 24 years, it’s significant that over that period, Microsoft has had only two CEOs and Intel has had five. Most people study the CEO when explaining a company’s performance, but they should first examine those who choose the CEO, the board of directors.

Looking back at these stories, asking “what if” is irresistible. What if Paul Otellini had said yes to Steve Jobs? What if any of Intel’s or Microsoft’s CEOs had been someone else? What if Intel, under a different CEO, had developed a successful GPU, the kind of chip that powers today’s AI engines (it tried)—would you ever have heard of Nvidia? Bill Gates said in 2019, “We missed being the dominant mobile operating system by a very tiny amount.” What if that tiny amount had shifted slightly? Whose phone would you be using today?

It’s all endlessly tantalizing but of course unknowable. The value of looking back and asking “what if,” is to remind us that every day leaders are creating the future—and neglecting their duty if they don’t learn from the past.

1. Success can be a company’s worst enemy. The great management writer Peter Drucker said every company must “abandon yesterday” before it can “create tomorrow.” But in a successful company, every incentive pushes leaders to protect yesterday. Intel and Microsoft struggled for years to create their tomorrows.

2. Leaders must be open to business models that seem strange. Whether giving away software or manufacturing chips designed by others as a separate business, both Microsoft and Intel faced competitors doing things differently.

3. Get everyone on the same page. Debate is healthy up to a point, but at Microsoft it continued far too long until Nadella became CEO and set clear priorities. At Intel a series of CEOs backed differing solutions to its declining business, which prolonged a muddled strategy.

4. Succession is the board’s No. 1 job, more important than all its other jobs combined. Everyone knows it, but some boards still do their job poorly. If they make a mistake, none of the other lessons matter. Considering that Microsoft has come through the past 24 years better than Intel, it may be significant that Microsoft has had only two CEOs in that period while Intel has had five.

5. Failure isn’t fatal. The Wintel story is a pointed reminder that all companies, including the best, suffer failures and fall into crises. There are no exceptions. The leaders of any company, even the grandest, must always be ready to engage the skills of organizational rescue, and know that even that can be part of greatness.

Defenses didn’t stand a chance against scoring outbursts this season—until referees took a closer look at the rules.

Midway through this season, the NBA had a strange problem: Its players were too good. Teams were scoring more efficiently than ever, stars were putting up 60 and 70 points in a single game and there was absolutely nothing that defenses could do about it.

So the league set about fixing things.

In early March, basketball fans began to notice a subtle but consequential shift in the sport. Referees forgave a little more contact from defenders. They were more suspicious of star players who flopped and flailed on their way to the rim. And in a mid-March memo to teams, the NBA confirmed that its competition committee “continues to evaluate the state of offensive vs. defensive balance.”

Put simply: The NBA was making defense legal again.

The numbers show just how much tougher it has gotten to score. Between February’s All-Star break and the start of the playoffs, scoring dropped leaguewide by eight points per game. There were six 60-plus point scorers before the break—and there has been only one since.

Saturday’s opening slate of playoff games continued the trend. In the first matchup of the day, the Cleveland Cavaliers held the Orlando Magic to just 83 points—the lowest total for a Cavs opponent all season. Across four games, three teams failed to crack 100 points.

“If the offensive player had the ability to just go off-path, create an ugly play and get to the free-throw line,” said Monty McCutchen, the NBA’s head of referee development, “it’s very hard to compete as a defensive player.”

At the peak of this high-scoring season, NBA basketball could seem like a drastically uncompetitive game. Players already gifted at putting the ball in the basket used the free-throw line to hoist themselves up to ever-more-outrageous stat lines. When Philadelphia’s Joel Embiid scored 70 points in January, he made 21 of 23 free-throws. When Dallas’ Luka Doncic put up 73 of his own four nights later, he made 15 of 16.

Early that month, McCutchen said, “We started to realize we had gotten relaxed,” often whistling legal defensive position as a penalty. The solution wasn’t to change the rules, he said, but to enforce the ones already on the books with greater rigor. Defenders couldn’t barge into the path of an offensive player—but neither could scorers simply veer out of their way to crash into an opponent and earn a foul.

Commissioner Adam Silver, addressing the skyrocketing point totals, repeatedly credited the skill and savvy of his league’s athletes. But behind the scenes, the league office was examining a situation that threatened to tip basketball out of balance.

“If a coach sees something wrong in a game, for him not to call a timeout and address it would be really poor management,” McCutchen said. “We have to live up to the rulebook as it’s currently written.”

As basketball has evolved over the decades, rules have had to evolve with it. When rugged, low-scoring play dominated the game in the 2000s, for example, the league did away with “hand-checking,” allowing offensive players greater freedom of movement. The change helped usher in the fast-paced and free-flowing era the league enjoys today.

Even though this season’s shift didn’t involve any new rules being put on the books, coaches had spent the first part of the year clamoring for the adjustment they have lately seen. In December, Golden State head coach Steve Kerr complained that star players were being allowed to “B.S. their way to the foul line.”

Those coaches got their wish. In an April game, the Boston Celtics and Milwaukee Bucks set a mark that seemed unlikely a couple months before. The two teams combined to shoot just two free-throws—a record low in an NBA game.

McCutchen noted that some scorers have been frustrated by the sudden disappearance of a friendly whistle. But over time, he expects that players and coaches will understand that these steps were taken for the overall health of the sport.

“When anyone takes a half-step back, the response we’ve gotten is that everybody has enjoyed the ability to defend legally again,” McCutchen said. “There’s a sense of, now we can compete on a level experience.”

On Saturday, the Minnesota Timberwolves didn’t have many complaints about the new way NBA referees are doing things. Minnesota’s playoff opponent, the Phoenix Suns, had averaged more than 118 points in three regular-season wins over the Wolves. In their Game 1 loss, hounded by a fearless Minnesota defense, they mustered just 95.

Effort to trump offer by Concord Chorus could trigger battle for music rights investor

Blackstone has won the backing of Hipgnosis Songs Fund’s board as the US private equity group seeks to derail Concord Chorus’s proposed $1.4bn takeover of the UK-listed music rights investment company

Blackstone said on Saturday it had made a proposal to acquire the business for $1.24 per share in cash, which would trump Concord Chorus’s offer on Thursday of $1.16.

Hipgnosis’s board said on Sunday that, having reviewed the proposal, it would be minded to recommend the alternative deal to its shareholders should Blackstone announce a firm intention to make an offer.

It added that it would continue to provide Blackstone “access to confirmatory due diligence to enable Blackstone to announce a firm intention to make an offer as soon as possible”.

The emergence of Blackstone’s offer could trigger a bidding war for the music rights owning company, which has been through a tumultuous period in the face of questions over its valuations, debt levels and governance.

This led shareholders to decide against the continuance of the fund in a vote last year, sparking a strategic review by a new board and ultimately Thursday’s agreement to sell the fund to US rival Concord Chorus.

The Concord offer was at a premium of about a third to the Hipgnosis share price before the bid was announced, and a 4.3 per cent premium to the fund’s September net asset value. 

That deal has already been backed by about 29 per cent of Hipgnosis’ issued share capital.

Hipgnosis’ music portfolio includes artists such as the Red Hot Chili Peppers and Shakira.

Blackstone was one of several parties to bid for the company as it went through a strategic review in recent months. The board said on Thursday that these offers had been “less certain, and at a lower value” than the agreed Concord Chorus offer.

A person close to Blackstone said that a firm offer could come as early as next week. They added that the private equity group was surprised at the Concord agreement, as it had been confident that it was the frontrunner and had been carrying out due diligence on its previous offer when that deal was announced on Thursday. Sky first reported that Blackstone was considering a new offer.

Blackstone already part owns Hipgnosis Song Management (HSM), the manager and investment adviser of Hipgnosis Songs Fund (HSF), although its new offer is separate to that holding. 

HSF was founded by music executive Merck Mercuriadis in 2018 to turn music rights into an asset class. He was HSM’s chief executive until February, when he became its chair. If Blackstone acquires HSF the music would be managed by HSM under its new chief executive Ben Katovsky.

Blackstone said HSM has an option to purchase the entire HSF portfolio of songs, which is exercisable for six months after the termination of HSM’s contract with HSF.

This means it could try to acquire the portfolio at market value if the board continues to back the Concord offer.

But the board could consider whether there are grounds to terminate HSF’s contract with HSM, according to a person close to the situation. That would remove HSM’s option to buy HSF’s portfolio.

Doing so would risk triggering a legal dispute between the two sides.

On Saturday, Blackstone said it “remains confident in the enforceability of the [HSM] option”.

“Blackstone is seeking to find a positive outcome for all shareholders at a fair and reasonable value; however, Blackstone and HSM value the contractual protections . . . and will vigorously defend HSM’s rights pursuant to the option if required to do so,” Blackstone said.

High rates and war fears hit smaller stocks harder—driving an unusual split in two of the major U.S. indexes

One of the biggest concerns amid the run-up in stocks in the first three months of the year was that the rally was dominated by the biggest companies. As it sold off this month, the market became even more top heavy. Blame the Fed, and a change in how investors react to it.

This isn’t how it was supposed to be. For weeks now Wall Street has been pushing the idea that the market is broadening out beyond the “Magnificent Seven” Big Tech stocks, helped by the dismal performance this year of formerly magnificent Tesla (down 41%) and Apple (down 14%).

It might be broader than seven stocks, but bigger continued to be better in April, with the notable exception of Friday, when several of the biggest stocks plunged. Divide the S&P 500 up into 10 groups and there is an almost-perfect descent in performance by size: from the biggest 50 down just 4.5%, to the smallest 50 down 8.6%. The pattern is more regular than it was in the first three months of the year, when the big were so obviously getting bigger.

This isn’t just about the S&P, which after all consists of the 500 or so largest stocks. The Russell 2000 index of smaller companies lagged badly behind on the way up, with its price rising less than 5% against 10% for the S&P in the first quarter. Then on the way down this month the Russell 2000 has fallen more, down 8.3% against a 5.5% decline for the S&P. The Russell Microcap index, which includes even the tiniest companies, rose even less and fell even more.

The main cause is interest rates, plus more recently fears about a wider Middle East war. Both hurt smaller companies far more than bigger ones—and for some bigger companies, higher rates even boosted the bottom line.

The impact of higher rates is part of the two-speed economy that has resulted from sharp rate rises, and then this year the evaporation of hopes for multiple rate cuts. Big companies are insulated from the impact of higher rates because they used their easy access to bond markets to lock in superlow-cost debt for a long time when rates were low. Many of the very biggest, particularly Big Tech stocks, are also sitting on huge piles of cash, which are earning more thanks to rate rises.

By contrast, smaller firms find it hard to issue bonds and borrow far more at a floating rate. As with poorer consumers who borrow on their credit cards, the cost of this debt has soared as the Fed tightened, hitting the profits of smaller companies. Goldman Sachs analysts calculate that almost a third of Russell 2000 debt is at a floating rate, compared with 6% for the S&P 500.

On top of that, smaller companies as a group have higher debt compared with earnings and more volatile earnings—making them less appealing when there is a flight to quality amid war fears.

This all shows up as the Russell 2000 moving strongly in the opposite direction to bond yields. Meanwhile there has been no link between moves in bond yields and the top 50 stocks this year—an unusual split between the two indexes.

Surprisingly, the excitement about artificial intelligence isn’t a great explanation for the biggest stocks winning. Sure, giant chip maker Nvidia soared 91% this year to its peak on March 25, but since then it is down 15%, including a plunge of 10% Friday, much worse than the Russell 2000. Just as it dragged up the performance of big stocks in the first quarter, it should have dragged them down this month—yet they still beat their smaller brethren. Further, AI can’t explain why there is such a neat pattern of outperformance by size. This isn’t just about a handful of huge AI winners.

The pattern is surprising for anyone who remembers 2022 and suggests investors are much more focused on profits now. In 2022, Big Tech and other growth stocks were crushed as valuations collapsed, even though profits were fine. The argument—a good one—was that for growth stocks, profit is further in the future than for cheap value stocks, so higher long-term bond yields should make those future profits less valuable. A bird in the hand is worth more when it earns a safe 4%+ yield than it is at 0%—so those two in the bush become less appealing.

The difference this time is that rates were high to start with. The 10-year Treasury lost almost 20% in price terms in 2022 as yields rose, while this year it is down only 6%. Back then investors sold growth much more than value, without much attention to size (both the largest and smallest members of the S&P did badly). This year investors bought growth more than value, while size mattered more.

This makes sense. As well as rate changes having a smaller impact when rates are already high than when they are superlow, investors have wised up to the varying effects of higher rates on the bottom line. Valuations, while still very high, are also lower than at the end of 2021. That doesn’t make the big-stock wins any easier to stomach for investors who keep hoping that smaller stocks will one day prove their worth.

International hotel chains step up plans to expand in Europe

Groups turn to rebrands and conversions to benefit from travel boom rather than invest in costly new-builds

International hotel groups are stepping up plans to add independent hoteliers and smaller brands to their European franchises as they seek to capitalise on soaring demand for travel amid high construction costs for new resorts.

Holiday Inn owner InterContinental Hotels Group and Marriott both set out plans this week to add hundreds of existing hotels across Europe to their brands to field a surge in holidaymakers from a post-pandemic travel boom.

InterContinental Hotels Group aims to double its portfolio in Germany to more than 200 hotels by 2028, through a 30-year franchise agreement with the country’s largest family-run hotel operator Novum Hospitality. The latter’s Yggotel, Select and Novum hotels will be rebadged as Garner, IHG’s new mid-range brand, while its niu brand will become Holiday Inn — the niu.

Marriott, meanwhile, said it would add 100 more hotels in countries such as the UK, Italy, Spain and Turkey by the end of 2026, by rebranding third-party hotels and converting existing buildings.

International hoteliers are racing to expand their portfolios at a time when high borrowing costs in Europe have slowed the pace of new construction. Property consultancy JLL said the number of conversions surged to an all-time high in 2023, with hotels converting offices as well as existing resorts.

“The momentum in Europe has been building and accelerating,” said IHG chief executive Elie Maalouf, adding that high construction costs and the continent’s large number of independent hotels presented “an opportunity”.

“[The region has] lower penetration of global brands, a lot of independent properties . . . but a strong industry,” he said. “People want more hotels.”

European travel is expected to remain strong this year, buoyed by a return of Asian and business travellers as well as events such as the Paris Olympics and singer Taylor Swift’s Eras tour in Europe kicking off next month.

Hotel groups are seeking a way to gain market share in the region at a time when growth in the pipeline of new hotels is slowing. From 2009 to 2023, overall European hotel supply grew at an annual compound growth rate of 1.3 per cent, according to CBRE. That is expected to moderate to just 0.9 per cent this year, well below the estimated 3 per cent annual growth in visitor arrivals, CBRE said. 

Mark Hoplamazian, chief executive of US hospitality group Hyatt, said building new hotels had become harder due to “very tough” markets for raising capital, causing the company to turn instead to converting and rebranding existing buildings. There is “much more demand than supply”, he said.

Hyatt, which owns brands including Grand Hyatt and Andaz, said in January it was adding more than 70 hotels to its portfolio across Europe, Africa and the Middle East.

Hotel operators said the European hotel industry was still rife for consolidation, with 59 per cent of hotel rooms still independently run, down from 65 per cent in 2008, according to industry data tracker STR. In the US, only 28 per cent of rooms are independent.

Groups such as Hilton argue that small hoteliers benefit from franchise deals, which give them the power of a bigger brand. However, such agreements come with a cost too, as hotels must pay fees to the franchisor.

Kenneth Hatton, CBRE’s head of hotels for Europe, said the travel boom had given an “air of confidence” to small hoteliers, who were able to raise their room rates without the added cost of being affiliated with a large brand.

But as demand starts to normalise later this year, they are likely to “acknowledge they need brand support for distribution”, he added.

Factory inspectors refuse to visit country over fears they could fall foul of tightened rules

Western pharmaceutical groups are warning of worsening disruption to supply chains because of problems certifying manufacturing sites in China, with some factory inspectors refusing to visit the country over fears of arrest for spying and others denied entry to facilities.

China is one of the world’s largest makers of active pharmaceutical ingredients and antibiotics and a major supplier of drugs to the EU and US. However, a tightening of anti-espionage laws by Beijing has led to concerns that foreign citizens gathering data on Chinese sites could be deemed spies.

“A large number” of inspectors from Germany, Europe’s largest inspectorate, are refusing to visit China for fear of arrest, according to the German Medicines Manufacturers’ Association (BAH).

Meanwhile, official data seen by the Financial Times shows some US Food and Drug Administration inspectors have been refused entry to Chinese production sites since the pandemic.

This has led to western pharmaceutical regulators struggling to enforce oversight of Chinese manufacturers. Drugs made in third countries and imported into the EU or US require certification by government inspectors and audits of production sites.

Covid lockdowns, manufacturing issues and low prices have already contributed to record shortages of essential drugs in the US and Europe.

During the pandemic, some audits of Chinese sites were carried out online or certification was prolonged without inspection — meaning there is a large inspection backlog with many certifications due “to expire by the end of this year”, according to Fatima Bicane, manager of pharmaceutical technology at BAH.

Disruption to inspections increases the risk of Chinese production sites losing their certification for western markets, exacerbating an already strained supply chain for generic pharmaceuticals.

“The big issue we have is that our member companies, in order to bring active ingredients and finished drug products from China to the EU, need certification from certain authorities,” Bicane said. “But a large number of German inspectors are afraid to travel to China because of the new national security law”.

“Adrian van den Hoven, director-general of Medicines for Europe, an industry body representing European pharmaceutical companies, said that ambiguity around the new anti-espionage law had led to concerns that “an inspector . . . in China could be accused of espionage”.

Data from the US FDA shows that the agency’s inspectors began to be turned away from Chinese factories in 2021. In total there have been 150 incidences of refused FDA inspections since then. There were 26 inspection refusals last year, down from a peak of 62 in 2022

“When you talk about antibiotics, the Chinese are in a very critical position as most of the starting materials for antibiotics are made in China,” said Jim Miller, an industry consultant who advises on pharma manufacturing in the US. “The world is very dependent on China for antibiotic ingredients and active ingredients.”

No western pharmaceutical inspectors have been arrested for espionage under China’s tightened espionage laws. However, a Japanese executive from Astellas Pharma was arrested last year in China on suspicion of espionage.

A spokesperson for the German chancellery declined to comment on whether Olaf Scholz had raised the concerns of the German pharma industry with President Xi Jinping when the two leaders met in Beijing last week.

The FDA said it had conducted 420 inspections in China since 2019, using some officials stationed in China but mainly inspectors travelling from the US, adding that the number of annual inspections “may fluctuate year-to-year” based on the number of routine inspections or specific product applications.

A spokesperson for China’s Ministry of Foreign Affairs said: “China is a country ruled by law. All Chinese law enforcement and judicial activities are carried out based on facts and the law. As long as one abides by Chinese laws and regulations, there is no need to worry.”

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Innovative Lawyers

After a tough start to the year, bonds should start to perk up. Where to invest for income now.

It was supposed to be a banner year for bonds. Instead it has been a bust so far. But the rest of the year could be more fruitful, if you know where to look.

The U.S. bond market is once again proving to be a minefield. Falling prices have pushed bond total returns down an average 3% this year, and no area of the market has been spared—even “junk” bond total returns are barely in positive territory, on average, despite yields topping 7%.

Many analysts expected better. The story heading into the year was that the Federal Reserve would cut interest rates sharply, giving bonds a tailwind. Falling rates generally push down yields and lift prices, leaving investors with both capital gains and interest income.

Yet yields have inched up on dimming prospects for rate cuts. Consumer price increases have proved tough to get down, recently coming in at 3.5% year over year, and with inflation still a problem for the Fed, prospects for rate cuts have dimmed. Traders see just a 15% chance of a cut at the Fed’s meeting in June, down from 51% a month ago, and it’s debatable if the Fed will even lower rates at all this year. Heading into the year, markets were counting on up to six quarter-point cuts in the federal-funds rate, pushing it down to 4% from its current range of 5.25%-5.5%.

The “higher for longer” scenario is punishing bonds. The 10-year U.S. Treasury yield has leapt from 3.95% at the end of 2023 to 4.63%. Overall, long-term bonds are down nearly 9% in total return for the iShares 20+ Year Treasury Bond exchange-traded fund. On an annualized basis, long-term Treasuries are enduring their worst stretch in 65 years, according to Bank of America.

Still, fixed-income experts see the rate climate improving if the Fed manages to push through a cut or two later in the year. Yields are attractive, and if the economy stays healthy, credit metrics should hold up, supporting prices in corporate debt. All that could make for good opportunities within the bond universe, particularly in investment-grade corporate, junk bonds, and floating-rate bank loans. Municipal bonds also are attractive.

“Adding exposure to high-quality bonds is a good idea for investors sitting in cash,” Matthew Palazzolo, senior investment strategist at Bernstein Private Wealth Management. “You can get an attractive level of income and price appreciation.”

Broad market indexes are dominated by Treasuries and agency-backed mortgage securities, essentially making them one-way bets on rates; corporate bonds offer more interest income in return for taking credit risk, with lower-rated debt yielding the most.

Two “core plus” ETFs—which include bonds that aren’t in the major indexes—to consider are iShares Yield Optimized Bond and Fidelity Total Bond. The iShares ETF, aiming for above-average yields, is a fund of funds and includes some riskier elements with 20% in junk bonds and 10% in emerging-markets debt. The Fidelity fund is also a little riskier than conservative core plus funds, according to Morningstar, but provides an “edge in risk-on markets.”

Given the market’s rate risks, some strategists recommend staying at the short end of the yield curve. Yields are slightly higher at the short end, resulting in an “inverted” yield curve, and some strategists see scant gains from venturing out to the long end. “There is a lot more risk on the long end than people realize,” says Doug Fincher, portfolio manager with advisory firm Ionic Capital Management.

Vanguard Short-Term Corporate Bond ETF tracks the market well. It yields 5.3% and has a “duration,” a measure of rate sensitivity, at just 2.8 years. That means it would lose roughly 2.8% if rates were to rise by a percentage point.

Other funds to consider include the JPMorgan Limited Duration Bond ETF and Pimco Enhanced Short Maturity Active ETF. The JPMorgan fund yields around 4.7%. The Pimco fund yields 5.3%, using derivatives and futures to help boost returns.

Within corporates, bonds issued by major banks look attractive. “High-quality credit is tighter but we’re still finding value in bank bonds,” says Mike Sanders, head of fixed income at Madison Investments.

One benefit of rates staying higher for longer is that it should support lending margins for banks, says Sanders. Bonds he likes now include five-year issues from megabanks JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup as well as “superregionals” like PNC Financial Services and U.S. Bancorp. Many of them yield above 5%.

With the economy holding up, several strategists see value in corporate issues in junk territory. “Given that we believe in the soft-landing scenario, we accept the fact that default risks are lower than historical. So, we like higher yield and bank loans,” says Jim Caron, chief investment officer of the portfolio solutions group at Morgan Stanley Investment Management.

To play it safe, stick with bonds rated just below investment grade, avoiding deep junk territory. The VanEck Fallen Angel High Yield Bond ETF focuses on issuers that have lost their investment-grade rating but remain at the upper echelons of junk. It has a solid long-term record, yields 6.7%, and is down less than 1% this year. Others to consider include mutual funds BlackRock High Yield Bond and Credit Suisse Strategic Income. Both yield above 6.5% and have long-term records that beat the category averages.

One other way to think about junk bonds is as a variant on equities. While they won’t perform as well in a bull market, they should tag along for the ride if the Fed can orchestrate a “soft” or “no landing” economic scenario after its aggressive rate hikes. “If you are comfortable with where the economy is and a soft landing, then the case for owning below-investment-grade bonds is as an equity substitute,” says Gene Tannuzzo, global head of fixed income at Columbia Threadneedle Investments.

One mutual fund playing both angles is Fidelity Capital & Income. It holds about 75% in bonds, mostly rated below investment grade, and keeps 18% in stocks, including tech companies like Meta Platforms, Nvidia, and Microsoft. It yields more than 5% and is ahead about 2% this year.

Senior bank loans, often referred to as leveraged loans, are holding up well in this climate. The bonds typically mature every few months, resetting their coupon payments with prevailing short-term rates. Yields are comparable to junk bonds due to loan credit ratings that are generally below investment grade.

If rates were to fall, coupon rates would decline, though the bonds would rally in price. Conversely, “if rates stay higher for longer, you’ll continue to get a nice yield on these types of instruments,” says Nicholas Brooks, head of economic and investment research at Intermediate Capital Group.

The largest ETFs in the space include iShares Floating Rate Bond and Invesco Senior Loan. Yields range from 5.8% to 8.1%, and the ETFs are up around 2% this year on a total return basis.

Municipal bonds could also rebound. Many muni funds are down at around 2% this year. But credit ratings are generally high—AA-rated or better—local tax revenue is holding up in a strong economy, and there’s a tailwind from infrastructure spending on roads and other projects that should boost tax revenue for states and localities, says Bob DiMella, an executive managing director at MacKay Shields.

“Increased infrastructure spending is going to continue,” he adds.

Yields get more attractive for investors in higher tax brackets, since muni income is exempt from federal income taxes. The iShares National Muni Bond ETF, for instance, yields 3.35%, equivalent to a taxable yield of 5.15% for investors in a 35% federal bracket. State-based muni funds may be better for investors in high-tax states like California, New Jersey, or New York. That is because investors don’t have to pay state taxes on muni bonds issued in the state where they live.

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