The “Great Consolidation” and Inflation

The recently proposed merger between Union Pacific (UNP) and Norfolk Southern (NSC) throws into sharp relief an accelerating—some would say disturbing—trend of mega-consolidation across a number of key industries (which I’m referring to as the “Great Consolidation” and which I’ll get into in further detail below).

If it goes through, Union Pacific’s acquisition of Norfolk Southern would result in a $200 billion behemoth that would effectively be the first transcontinental railway in North America under a single operator, connecting both East and West coasts. It would also, in the words of one observer, “mark the most significant consolidation in the [transportation] sector in decades.”

Within days of the proposed merger’s announcement, rumors surfaced that two of North America’s biggest railroads, the Berkshire Hathaway (BRK.B)-owned BNSF Railway and CSX Corp. (CSX), were also exploring the possibility of a merger. According to Reuters, BNSF has engaged Goldman Sachs to explore acquisition options, while CSX is also in talks with financial advisors to assess a possible deal. (However, Berkshire’s CEO, Warren Buffett, told CNBC that no one from Goldman has yet spoken to him or to CEO-in-waiting Greg Abel about a deal.)

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Of course, the already shrinking rail industry was further consolidated in 2023 when Canadian Pacific bought Kansas City Southern, creating CPKC (CP), the first railway spanning Canada, the U.S. and Mexico. On that score, industry sources report that either CPKC or Canadian National Railway (CNI) could act as spoilers for the proposed merger.

Further muddying the railway consolidation waters, CPKC and CSX issued a joint press release on Monday announcing a new east-west freight route called the Southeast Mexico Express, which will connect shippers in Mexico, Texas and the southeastern U.S. As observed by Frank DeMatteo of Investing.com, “The timing of the announcement raised eyebrows.”

Meanwhile, in the financial sector, an M&A boom is underway among Europe’s banks this year, with European banking deals reaching over $30 billion being announced since the start of this year, up 100% year-on-year. This has understandably been a cause for consternation among several of Europe’s regulators, which see potential danger in the banking industry consolidation boom.

That’s why I found troubling the recent Financial Times article which reported that the European Union (EU) is cracking down on member nations interfering with bank M&A. Already, the EU has issued warnings to Spain and Italy for obstructing major bank deals, which it says constitutes a breach in EU banking regulations and infringes on the exclusive authority of Europe’s central bank to supervise member banks.

The EU’s latest move is ostensibly designed to strengthen the bloc’s financial sector, but critics see only a move toward reduced competition in banking.

What both stories have in common is the acceleration of the aforementioned multi-industry, multi-decade consolidation trend, which could be colloquially styled the Great Consolidation—and which arguably amounts to oligopolies being established across countless industries. My purpose in bringing this to your attention is to underscore how it plays into one of our major investment themes, namely, the phenomenon of secular inflation.

In the case of the latest railroad merger proposals, a further shrinkage of the North American rail industry could lead to increased freight rates for intermodal and bulk transport, which in turn would likely increase inflation due to shippers having fewer choices and higher transport costs (in turn leading to shippers passing the subsequently higher prices on to consumers).

Moreover, additional consolidation in the rail industry could prompt Class I railroads to prioritize higher-margin routes and customers, with the result that smaller sectors are underserved. Of course, any supply chain disruptions that might result from this would further exacerbate inflationary pressures.

In the case of Europe’s banking consolidation wave, the reduced competition resulting from it, as the number of banks diminishes, would result in less competition and, likely, higher interest rates on loans. Higher borrowing costs, in turn, can push the prices of goods and services higher, contributing to inflation. (And indeed, the inflationary trend of the last few years has been global in nature.)

However, inflation is currently more pronounced in the U.S. than it is in Europe, with headline CPI inflation around 2.7%, unchanged from the previous month, while core inflation (excluding food and energy) is 2.9%. Both metrics are above the Fed’s long-term inflation target of 2%, which implies the central bank has its work cut out for it.

Inflation’s naysayers contend that wage increases in the U.S. are outpacing CPI inflation based on the year-on-year hourly average wage for June rising 3.9% for all non-farm workers. However, it must be pointed out that there’s a distinction between average and median wages, with the former metric being skewed by very high-income earners. The latter metric isn’t influenced as such, which provides a more accurate picture of the real wage picture in America today.

By contrast, median wages are telling us that for millions of workers, earnings aren’t keeping pace with inflation. The Fed’s dataset, “Median usual weekly real earnings for wage and salary workers 16 years and over,” shows that the actual year-on-year increase for wages is only 2.17% as of late July (see chart below).

That’s well under the current 2.9% core CPI rate—25% below it to be exact! The bottom line is that the purchasing power for a substantial number of workers isn’t keeping pace with rising living costs … and that’s a definite reason for concern.

As for how this trend ties into financial asset markets, I can only reiterate that my expectation is for inflation to remain an ongoing problem going forward—particularly as the White House’s tariffs begin to be factored into production and shipping costs in the coming months.

As previously emphasized, this means investors should probably continue focusing on sectors and industries that are poised to outperform in an inflationary environment, including consumer staples, healthcare, metals/mining and energy.

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