- Income inequality may be a hidden driver of equity prices.
- In a very equal society, equities are less in demand as the need for shelter and consumer goods trumps the need to own stocks.
- Rising income inequality mechanically drives equity demand up and with it, returns.
- The 40-year secular bull market can be explained by strong demand growth fueled by income inequality and limited supply due to share buybacks.
- Income equality trends and the SEC’s decision on share buybacks have contributed to the S&P 500’s real price return of 6.9% per year from 1982 to 2021.
- Had income inequality trends not reversed or the SEC not permitted buybacks, the S&P 500’s real price in 2021 would have been starkly different.
- Rising income inequality will continue to propel equity markets unless and until the ballot box decides otherwise.
Economists and market participants have introduced increasingly sophisticated models over the past half-century to explain the ups and downs of the equity markets. With some adjustments to corporate earnings measures and risk-free rates, these methods describe market movements quite well. However, a simpler way to account for how equities behave is to de-emphasize their financial nature and think of them as high-end consumer goods whose prices are determined by the forces of supply and demand.
According to Abraham Maslow’s hierarchy of human needs, equities occupy an elevated position. We buy stocks only after we have seen to our shelter, food, transportation, education, and other more immediate concerns. The higher our income, the freer we are to invest in equities, and vice versa.
Based on this perspective, income inequality becomes a hidden driver of equity prices. In a very equal society, equities are less in demand because the need for shelter and consumer goods trumps the need to own stocks. Thus, rising income inequality mechanically drives equity demand up and with it, returns.
On the supply side, net share issuance has been anemic ever since the Securities and Exchange Commission (SEC) legalized share buybacks in 1982. Classical economics explains what happens when demand for a good rises faster than its supply: the real price of the good must increase. Therefore, the 40-year secular bull market that started in 1982 has been the direct consequence of strong demand growth fueled by income inequality, among other factors, combined with supply that has not kept up.
The S&P 500’s real price return during the 1982 to 2021 bull run was 6.9% per year, which is significantly better than the 0.7% generated annually between 1913 and 1982. Of the excess return, 2.4 percentage points stems from the increase in income inequality, and 1.4 percentage points result from the supply squeeze caused by the SEC’s decision on share buybacks. The rest is due to growing equity allocations, lower inflation, and lower interest rates, among other factors.
What if income inequality trends had not reversed or the SEC had not permitted buybacks? The S&P 500’s real price in 2021 would have been starkly different. The market would have risen in all scenarios, but there is a major difference between the S&P 500’s actual increase and the most bearish scenario. Income inequality is not the sole determinant of stock market performance, but it is a critical factor that was previously hidden from view.
Looking ahead, cyclical headwinds will play a role in the secular bull market’s future viability. However, rising income inequality will continue to drive equity markets unless and until the ballot box decides otherwise.
