- Since the 1980s wealth inequality has greatly increased
- The increase in inequality has correlated with an increase in the price of stocks and bonds and a decrease in rates of inflation
- We look at proposed populist policies and how they would likely asset prices and inflation
The chart below shows the wealthiest people in the USA has gained a greater share of the total wealth in the United States over the last 40 years. Globally people with more than 30 million dollars in assets make up just 0.003% of the world population, but hold a staggering 11% of global wealth.
At the same time the middle class has seen their share of global wealth erode from 45% to less than 30% over the same time period. And while the middle class has seen real returns with total wealth in the United States rising from an inflation adjusted 30 Trillion to over 100 Trillion in 2018.
By my math the bottom 90% has seen their wealth grow from around 14 trillion dollars to 25 trillion dollars, while the top 0.1% has seen their wealth grow from 2 trillion dollars to 25 trillion dollars. At the same time we have seen inflation rates fall from the highs in the 1980s to the sub 2% levels we have experienced over the last 10 years even as we have expanded global debt as a percentage of GDP from 100% in 1980 to over 200% today.
Alongside stocks, bonds too have had a 40 year rally and increase in asset prices.
The reason why this all makes sense comes down to supply and demand. As wealth has expanded one reason there has not been an increase in demand for goods and service leading to greater inflation is that the wealth and income of the bottom 90% grown slowly relative to the wealth of the richest. And what do the very rich do with their money? They invest it in stocks, bonds, and businesses. So it makes sense given the increased demand from the wealthiest, that demand for these assets has increased and the price of theses assets have skyrocketed with CAPE ratios tripling and yields falling to negative real rates of return.
What’s interesting to me is how this plays out over the next 2 presidential cycles between now and 2024. While any change in the wealth distribution and trend is far from certain, it’s clear that there is a growing populist trend(popularized by Ray Dalio) of redistributing wealth from the very rich to the bottom 90%. I see 3 primary ways that wealth distribution is likely to happen.
- Simple increases in tax on the incomes, wealth, capital gains of high net worth individuals. Elizabeth Warren’s 2-3% wealth tax could raise almost 3 trillion dollars over 10 years. That 3 trillion dollars would come out of the equity and bond markets where the very wealthy are currently invested, reducing the trend of rising asset prices.
- Increased taxes on businesses on a relative basis. Whether that is as simple as just reversing Trump’s corporate tax cut or implementing a value added tax. Any increase in taxes would decrease the earnings companies as a whole, decrease the companies ability to pay and increase their dividend, and reduce solvency of companies that are treading water.
- Last any redistribution of wealth to the bottom 90% through increased benefits, lower taxes, or even more progressive plans for universal basic income. This would form an inflection point in the demand for consumer goods and services. Mid to low income housing prices would also rise, paving the way for much higher inflation.
When making a prediction, I always like to form a base case, bull case, and bear case as I try to probabilistically discount future changes in macro asset prices.
Bull Case: Through 2024, control of the senate, house of representatives, and presidency remains split across party lines. There is no ability for partisan policies that redistribute wealth or increase business taxes. This is business as usual. Demand remains strong from the very wealthy as they maintain their wealth. Fears of base and bear case are stifled and stock markets are given the chance to rally to new highs with 10% annualized returns over the next 6 years. I give this case 40% odds.
Base Case: Through 2024, control of the senate, house of representatives, and presidency remains split for much of the time, but the margin is small enough for the policy to be passed that increases taxes on the very wealthy and or businesses. There is a flattening in demand across all asset classes and with lower corporate earnings stocks fall somewhat but catch enough of a bid from the sidelines to trend sideways. Increased taxes go to pay down government debt and there is little wealth redistribution. I give this case 20% odds.
Bear Case: Through 2024, we elect a democratic presidents with policy promises of wealth redistribution. Democrats also gain control of the both house and senate for at least 2 years. They are able to pass both increases on tax on the wealthy, and retribution of that wealth to the bottom 90%. There is a sharp inflection point in the share of wealth chart. Inflation spikes above 5%, stocks and bonds lose demand from the wealthy who own the market falls as they are forced to divest their assets. There is not enough bid from elsewhere to catch the falling knife, and stocks and bonds both lose at least 50% of their value. I give this case 40% odds.
It’s strange to have a middle/base case with only 20% odds, but I think a two party system lends itself to binary results and outcomes. The bear case might also seem extreme given the predicted outcomes. It’s far from certain that this case happens and how the stock market actually behaves is anyone’s guess. I do think we should expect increased volatility over the next 6 years as the near term odds of these outcomes comes into greater focus and the market starts to discount the possibility of an imminent outcome more appropriately.
I emailed this idea to Ben Carlson and Michael Batnik who host the fantastic Animal Spirits Podcast. They were nice enough to respond and compared this concern to overblown concerns that baby boomers will crash the stock market. They are probably right and there are any number of scenarios where the asset prices defy negative expectations. However I do think there are 2 key differences. The speed at which the demand shifts, and how priced into the market this phenomenon is. I also but this idea to the test in the ChangeMyView reddit if you want to hear alternate views. Whatever you think let me know on twitter @EverywhereData.
As a relatively young investor the prospect of lower asset prices excites me. While my asset allocation is only slightly shifted away from stocks tactically, I am also keeping a greater share of my assets in short term bonds which offer yields almost as good at 1 year than at 10 years. I look forward to the opportunity to put a greater share of that cash to work and am appropriately position for all three cases.