Nothing seems to stop stocks from going up. Not inflation--the 5 per cent print for May for US consumer price inflation left stock markets unfazed. Not the fact that output losses compared to the pre-pandemic trend will be lower even in 2022—for India it will be 9.3 per cent lower, says the World Bank. Not the worry that growth in the advanced economies has come about on the back of massive fiscal and monetary stimulus, which should lead to the question about what happens to demand when these are withdrawn, a question the markets aren’t even remotely interested in asking. That the record increase in debt burdens will weigh on economies is not considered. Nor the relentless rise in commodity and input prices, which could squeeze margins. Stratospheric valuations are ignored or justified with ingenious sophistry. And any fears that new variants of the virus could outwit vaccines are laughed out of the markets. All the conditions for a market melt-up are in place.
What accounts for the yawning gap between the markets and the state of the economy? What gives the bulls this overweening confidence, this hugely positive sentiment? In markets, sentiment is just another name for the weight of money. When money floods into the markets, sentiment is high. When it runs out, sentiment is low. It’s as simple as that.
The question then becomes: what accounts for the torrent of money flowing into stocks? The developed country central banks are obvious culprits, with their quantitative easing programmes -- as Ed Yardeni has shown time and again, the rise of the S&P 500 mirrors the increase in the assets of the Fed, the ECB and the BoJ combined. The bulls point to this tsunami of money depressing interest rates to rock bottom, thus boosting flows into equities.
There’s the usual talk of the stock markets being forward looking, presumably meaning that they ignore all current problems and gaze in rapture instead at the sunlit prospects ahead. Some point out that the economy is getting back on its feet, the recovery is gathering steam and earnings forecasts are being revised upwards. Vaccinations, of course, are seen as the panacea.
Many of these are good reasons, which investors must take note of. The investment themes we touched upon this week included down and out sectors making for value buys; export markets -- including this stock with markets across the world; the policy change affecting sugar stocks; improving balance sheets; the China plus opportunity; a play on steel demand; a future IPO; and a new sector with immense growth potential.
The stocks we recommended this week were in sectors as diverse as auto ancillaries here and here; fast food; transport finance here and here; footwear; aviation; LNG imports; and housing finance.
What may have been ignored in the cacophony is the elephant in the economy, the X-factor that has ensured a steady gush of money into the markets over decades, pushing up asset prices. That X-factor is increasing inequality.
A vast number of studies have shown that inequality has been rising in most countries in the past few decades. Thomas Piketty showed that income inequality in India is back to levels last seen during the British Raj. A recent study by McKinsey Global Institute said that for OECD countries, total labour compensation fell by 6 per cent between 1994-96 and 2016-18, while net capital income increased by 81 per cent. A 2019 Credit Suisse report pointed out that the poorer half of the Indian population owns a mere 2.8 per cent of the country’s wealth, while the top 10 per cent owned almost three-fourths.
The rich can’t consume all that income, although it isn’t for want of trying -- a recent media report said Mercedes-Benz has already, in these COVID-infested times, sold out the entire lot of the super-luxury GLS-Maybach cars it plans to bring to India this year. But even conspicuous consumption is not enough, the rich have what economists call a low marginal propensity to consume. As inequality goes up, they save humongous amounts out of their incomes and invest their savings in the asset markets. That is one big reason for the secular trend of rising asset market prices worldwide.
And with central banks making sure that interest rates remain low, more and more money is finding its way into equities. It’s a self-reinforcing trend -- inequality leads to more market investments which raise asset prices, which increases inequality further.
What about the households who don’t have the wherewithal to invest in the markets? For many of them, it’s a double blow -- they not only lose out on capital gains, but they also earn lower interest on their meagre savings. India Ratings has shown how in India over the years, the tax burden of households has increased as the lowering of corporate taxes has resulted in the state resorting to a higher share of indirect taxes to prop up its revenue—the steep taxes on fuel being the obvious example. In the US, reports say that firms have increased their reliance on labour-saving technology during the pandemic, which would mean fewer jobs.
The pandemic, of course, has only exacerbated inequality. That is seen in businesses as well—smaller firms are struggling to survive, while the larger ones have been able to use the low interest rates and the strong market conditions to fortify their balance sheets. They have gained market share. And since it is the largest firms in the economy that are listed, the stock market too has benefited from the underlying change in business conditions. Whether the higher market share is enough to offset the loss of purchasing power of vast sections of the Indian population though is a moot point.
There is nothing surprising about these trends, it’s the nature of the beast. Deng Xiao Peng had brushed aside concerns about inequality with the dictum, "Let some people get rich first". The implication was that some of the moolah would eventually trickle down to the masses. But while that may have happened in China, with its stupendous growth, it hasn’t happened in many other countries. The worry is that when inequalities become too glaring, the pitchforks come out. There’s the risk of a political backlash. That backlash may already have started, albeit tentatively and timorously.
As for the ethical and moral aspects of rising inequality, the poor we shall always have with us.