Argument for the Next Bull Run by Stephen Duneier First published November 12, 2014
In Declawing the Federal Reserve, I argued that wealth disparity was a game changer for the composition of the Fed’s target audience, rendering its monetary policy impotent. This edition explains why it’s too early to worry about wealth disparity’s impact on growth and corporate earnings. Instead, history would suggest that wealth disparity has much more room to run, and public policy in places like Europe and Japan, will make the divide, and a stock market burst higher, all but inevitable. Meanwhile, the outlook for inflation and growth, their intended goals, aren’t nearly as certain. SOMETHING HUGE HAPPENED Labor markets are a hot topic at the moment, but rather than focus on its impact on inflation, I want to look into its relationship with growth. I’m going to skip past the structural vs cyclical participation rate debate and get right to the indisputable trends. To begin with, I overlay the annual growth rate of the actual number of Americans employed with nominal GDP growth (see People at Work chart). Naturally, you would expect to see a relationship between the two, but there’s so much more to glean from this chart.
Most notably, something huge happened around 1978, a year rarely mentioned in economics courses, but from the look of things, should have garnered a syllabus all its own. However, before we dig into why things shifted that year, let’s note what changed. The trajectory and volatility of both nominal growth and employment was altered, with GDP peaks becoming more and more muted, especially relative to employment peaks. (I wrote at length about velocity in the previous edition, so I will simply mention that it may be a factor here.) Also, in looking at the cyclical peaks and troughs of the current well-established downward trend, we would appear to be much closer to the top than the bottom. The reason that’s important is that the odds should favor reversion to the downward trending mean, putting the burden of proof on those who would argue for a break of the trend. In other words, if you are going to argue for greater growth in the employed population (likely requiring a higher participation rate), you’ll need to make a pretty compelling case. Looking at a chart of the share of total U.S. wealth controlled by the top 0.1% (see Rise of the Upper Upper Class chart), once again 1978 jumps out as a fulcrum point. (As an aside, when looking at wealth disparity charts like this, keep in mind they represent relative proportions, not absolute values, so when one group spikes, another group must be collapsing. These charts also tell you nothing about the growth of the pie itself.)
THE TRIGGER After considering numerous possible factors that could have caused such a disruption, one jumped out as being worthy of further investigation. 1978 marked the beginning of some fairly radical tax reform, particularly as it relates to capital gains and the highest income tax bracket (see Taxing the Top chart). Yes, at a time when Democrats controlled the Oval Office, House and Senate, wealth disparity began its march, so you could say, Jimmy Carter’s administration gave birth to the rise of the upper upper class, while Reagan’s nurtured its growth. But I’m getting ahead of myself.
Although the idea that taxation could be a powerful tool for wealth redistribution makes intuitive sense, I’m concerned about leaping to such a grand, far reaching conclusion based on just one data point. So I pulled the charts back further to see if there were other episodes which might support or refute the view (see Wealth Disparity in America chart). By going back to 1917, we now have two additional turning points to investigate. One in the early 20’s and the other in the early 30’s.
Before we move on to the taxation chart, take a second to absorb the extreme level of wealth disparity and the speed at which it jumped over the course of the 1920’s. Now, compare that to where things stand today, and you’ll see there is plenty of room for this to run. (The same can be said for equity markets, but I’ll come back to that point shortly.) TWO CERTAINTIES: WEALTH AND TAXES Let’s see if the taxation chart provides any clarity when we pull it back to cover the same time frame (see Two Certainties chart). For ease of comparison, I’ve simplified things by charting the average of the top tax bracket and capital gains tax levels, and overlay it with the wealth controlled by the bottom 99%. Based on the data, it’d be hard to argue that there isn’t a very strong structural relationship between these two factors.
What this tells me is that the natural order for an economy is much like a game of monopoly or a no-limit Texas Hold ‘Em poker tournament. Ultimately, the game progresses until one person controls all the money. The first line of defense against this fate is some unnatural force, like a government which redistributes wealth through proportional taxation and spending. Therefore, if you believe that wealth disparity will eventually become such a disruptive force that its course will need to be slowed or reversed, watch the national discourse regarding taxation and federal spending as a key trigger. Until then, it’s just conversation. Based on the mid-term election results and current level of distaste for government spending programs, I would argue we’re still in the conversational phase with plenty of room to run. (I’m considering the addition of Fox News viewership numbers to my macro dashboard.)
RELEASE THE BULLS What are the implications of wealth disparity spiking to the next level, then? Well, before I get to that, let’s consider some other factors currently in place and potentially on the horizon, that argue in favor of wealth disparity not just continuing at its current pace, but experiencing a leap higher, similar to what we saw in the Roaring 20’s. Low inflation, technology moving up the food chain (read The Second Machine Age), tight credit standards, higher equities and perhaps the most powerful of all, central bank asset purchases at a time when federal budgets are not ballooning. This makes what the ECB and BoJ are embarking upon so powerful. While they believe money will suddenly find its way into the real economy, they are missing the key piece of the puzzle necessary for that to happen - government spending. You see, just as the Fed doesn’t fully comprehend how drastically wealth disparity has affected its target audience, neither do the Europeans and Japanese. Abe and Draghi are simply putting more money in the hands of savers, therefore they should expect the crowding out from their asset purchases to flow into other financial assets, like equities, not the real economy. You might think, it’s too late. Equities already had their run. Au contraire. Take a look at the Dow Jones Industrial Average (S&P doesn’t go back as far) using log normal returns. Note the periods with the most extreme slopes, namely the 1920’s and 1978 to the end of the century, those periods when wealth disparity also took off. What’s notable is the lack of a significant run higher in equities since 2000, even though wealth disparity has continued unabated.
MEGA-WEALTHY MISSING OUT Much like it was in the 20’s, we all know about the fragility of the economy and the issues that make it unsustainable. As I said in the previous edition of Macro Radar, this is ultimately a giant Ponzi Scheme, but sometimes you can be too smart (or too risk averse) for your own good. You could argue this has been the case for the mega-rich since the financial crisis. Typically, they capitalize on equity bull runs far better than anyone else, but this time around, they’ve been sitting on the sidelines (see Where the Mega-Rich Park Their Wealth chart).
Perhaps the crowding out effect from ECB / BOJ purchases will mark a turning point for this ratio, pushing wealth out of fixed income and into equities, thereby triggering the start of the next lurch higher for stock markets. Maybe it will be higher growth expectations when low oil prices during the holiday shopping season spark higher discretionary spending or a Fed that becomes more focused on inflation than employment. Fact is, there are a whole host of reasons for equity markets to spike higher, and it shouldn’t matter that most of them are not based on sound economic fundamentals, like higher growth rates or improved corporate earnings. (Yes, I hear myself.)
The laws of supply and demand ultimately drive price action. When you reduce supply (assets available for purchase) and increase demand (wealth in the hands of savers), prices go higher. P.S. There are as many lessons to be learned from the years leading up to 1929 and 2008 as there are in the aftermaths.
About the Author For nearly thirty years, Stephen Duneier has applied cognitive science to investment and business management. The result has been the turnaround of numerous institutional trading businesses, career best returns for experienced portfolio managers who have adopted his methods, the development of a $1.25 billion dollar hedge fund and 20.3% average annualized returns as a global macro portfolio manager.
Mr. Duneier teaches graduate courses on Decision Analysis in the College of Engineering, as well as Behavioral Investing, at the University of California.
Through Bija Advisors' coaching, workshops and publications, he helps the world's most successful and experienced investment managers improve performance by applying proven, proprietary decision-making methods to their own processes.
Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America, Managing Director in charge of Emerging Markets at AIG International and founding partner of award winning hedge funds, Grant Capital Partners and Bija Capital Management. As a speaker, Stephen has delivered informative and inspirational talks to audiences around the world for more than 20 years on topics including global macro economic themes, how cognitive science can improve performance and the keys to living a more deliberate life. Each is delivered via highly entertaining stories that inevitably lead to further conversation, and ultimately, better results.
His artwork has been featured in international publications and on television programs around the world, is represented by the renowned gallery, Sullivan Goss and earned him more than 50,000 followers across social media. As Commissioner of the League of Professional Educators, Duneier is using cognitive science to alter the landscape of American K-12 education. He received his master's degree in finance and economics from New York University's Stern School of Business.
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