Trending
Written by: Tim Pierotti
The decline of stocks and property held amid an increasingly concentrated minority risks economic weakness. The markets tail wags the economy dog.
We have written and talked a lot about “The K-Shaped Recovery”: the bifurcation of wealth in this country between those who own assets and those who do not. The chart above from the outstanding economists at Moody’s (hat tip to Mark Zandi) shows just how uneven the economic recovery and wealth distribution have been. The chart illustrates that we have now gotten to where 50% of consumer spending comes from just 10% of the economy. That 10% owns the lion’s share of stocks and property wealth.
The late great Charlie Munger coined the term “Febezzle” building on the famed economist John Kenneth Galbraith’s concept of the “bezzle”. Galbraith’s metaphorical construct was that when someone is embezzling funds, the immediate impact is more overall spending as the embezzler has more assets and the embezzled doesn’t yet know they have less assets. Obviously, in the end there is a deleterious outcome.
In 2021, in China Financial Markets, Michael Pettis wrote, “Munger’s insight (the Febezzle) was that rising stock or real estate prices can generate income and wealth effects whether or not these rising prices reflect real increases in the earning capacity of these assets, that is to say in their real fundamental values…The point is that financial markets can create temporary impressions of false wealth very similar to those of Ponzi schemes without any need for an embezzler”
Pettis surmised, “If we do see any sharp correction in US stock and property markets, the risk is that it sets off much slower consumption growth, and this, the main driver of economic growth, will cause total growth to drop in a self-reinforcing loop.”
There has been extraordinary wealth accumulation among the wealthiest cohort since the pandemic. That wealth and confidence of more wealth has driven unprecedented consumer spending levels that have fueled the overall economy. If market volatility and a correction erode that confidence, savings rates will rise, risk-taking and consumption will fall. The risk is that a vicious cycle ensues where market weakness begets economic weakness, which begets further market weakness.
Despite historically high valuations, we have been sanguine on risk assets since January of last year. What has changed is the dramatic rise in policy uncertainty that is being reflected in recent consumer and corporate sentiment indicators. Excessive fiscal spending has, in part, underpinned the consumer income growth story in the US and markets are now worried that governmental tailwind is coming to an abrupt end. Will tariffs ultimately be a tool to support the American middle-class, I hope so, but I don’t know. I do suspect, however, that there will be significant economic disruption, retaliation and other unintended consequences from an economic policy transition as dramatic as the implementation of large tariffs on our biggest trading partners.
Not every dip is a buying opportunity. Remember, Bulls make money. Pigs get slaughtered.
Related: Reading Between the Lines: The Treasury’s Plan for Inflation