The Post COVID World: Fixing Inequality in Income and Profits – It’s a Bigger Problem Than Most Understand
I’ve written about the Value Line Geometric Average before and what it represents. I recommend readers review the following to get a better understanding.
The geometric average better represents the realized return that most investors experience from the average stock. For the US markets, the difference between a traditional arithmetic (weighted) index and the average stock return is telling. It speaks to the inequality we see in the economy that has only been magnified in recent years. Five stocks had trillion dollar valuations prior to COVID-19. I’ve long believed the biggest problem in the world for decades now is inequality. And the vast majority of policies we have in place like corporate bailouts and unprecedented quantitative easing (debt monetization) do not help the average company or the average citizen. We have seen this with parts of the rescue package going to companies that don’t need it as much as very small companies that will not likely survive. Over the past 20 years, the geometric average of the US market is FLAT! And the bottom half of people have almost no exposure to equities. Their income comes from their labour.
The majority of profits and movements in the traditional market cap (size) weighted indexes we know (Dow Jones or Standard and Poors) are driven by fewer and fewer stocks. Here are some facts:
- Top 20 Stocks in US are about 30% of the market (VTI) and 15% of the world (VT) index
- VTI the total US market ETF has 3,556 holdings
- About 30% of the Russel 2000 (IWM) Small Cap stocks (the bottom half of this index) lose money with the Best Economy EVER!
- RY (6.1% of TSX) is the 85thlargest in the world (VT). It would be the 62nd largest in VTI. Canada is a very small player in the world capital markets.
All these facts argue strongly for index (ETF) based investing as opposed to trying to pick individual stocks. There is nothing at all wrong with trying to pick the winners, but it’s hard. And it’s more expensive. But that’s not the main reason why I raise the issue. Inequality is the major issue. It impacts the social aspects of the world considerably. Afterall, do we not want policies to make a better world for everyone? I certainly do. The next chart prepared by my good friend David Rosenberg at his new firm Rosenberg Research. You can get a free trial to his research here. He is easily one of the most thorough, thought provoking independent economists in the world.
David did an important analysis of inequality recently. Not inequality in stock returns like I highlighted above, but for people. One of the charts that struck me as most important to this inequality problem (and why Donald Trump was likely elected). It’s what every politician talks about, but has not been able to fix, is the hollowing out of the middle class. It’s why almost 50% of Canadians are a paycheck away from insolvency. The bottom half is falling behind in the stock market and in the real world. I see this as troubling for a good economy and strong growth in the future. The current global government support for people and business is important to be sure, but it’s not going to fix one of societies main issues–inequality. Until we fix that problem, I believe the global economy will underperform. The unprecedented support from governments is NOT a reason to be bullish.
The last time Labour’s Share of Income was this low was back in the 1930s. And one of the learnings from the Great Depression was that unions became stronger and wages rose significantly. This is a good thing to be sure for the average worker. In the 1970 it helped lead to massive inflation. This means that margin pressures are coming as wages rise. It means that the market multiple is too high. Back in the post WWII period for decades, the multiple was in the 13-17x range. I think we are going back to that period. For me, that means markets are still far too expensive.
Inequality has been the biggest problem over the past decades
- Policies to boost stock markets increase inequality
- Political shift to extremes
- More extreme LEFT and RIGHT policies are coming
- Taller boarder walls (RIGHT)
- Localized supply chains (RIGHT)
- Higher costs (LEFT)
- Income rising, stronger unions (LEFT)
- = STAGFLATION
I think a lot about the policies the world needs to solve some of these issues. I don’t see them today. What I see makes many of the inequality issues worse. I’m not trying to be bearish. I sometimes get accused of being too bearish. I get paid as a portfolio manager to position portfolios for the most likely outcome. Capital preservation for now seems more important than seeking growth. We need more sleep-at-night for a while longer. The growth seeking time will come too, as it does in every cycle, but we have significant hurdles to get through before that period comes. The only question is how long it takes. Good health to all.
It’s time to have your plan to go shopping over the next few months. These will be the best valuations to own in more than a decade. Our Spring BNN Bloomberg Roadshow is being converted to weekly webinars (not live events) for this series. Please click here to register for free. If this unprecedented period of volatility does not convince you that one should be cautious when valuations are unstable so that you can get aggressive into periods of panic, you need to sign of for the upcoming series and learn more about the tools you need to use. We will host a weekly Berman’s Call online where Larry will update his thoughts on the market and have lots of Q&A and ideas to help you with navigating the markets.
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