Would You Rather Be Rich or Young?

"It’s been said that young people dream of being rich, and rich people dream of being young."
– Antonio Regalado, MIT Technology Review

Note: I began writing this Early Look mid-day yesterday and the introduction was intended to be upbeat/optimistic. I’ve chosen to leave it as is because I think the world could do with a little more positivity and a lot less hate. Sadly, the events in Texas yesterday have cast a long shadow over the last 24 hours and I would respectfully offer my deepest condolences to those so terribly impacted.

Today’s Early Look is about Wealth, more specifically, it's about the Wealth Effect. But before we go there, I want to start by teasing the tagline – Would you rather be Rich or Young?

It’s an interesting question. What if you could be both? What if you could be both forever?

I recently read the book Lifespan: Why We Age – and Why We Don’t Have To by David Sinclair. It’s an incredible book. Sinclair runs an epigenetic research lab at Harvard University and is considered by many to be at the forefront of understanding the triggers for cellular aging. His lab is focused on finding ways to slow, and ultimately to reverse aging. Sound like science fiction? Give the book a read and decide for yourself. I believe that we are much closer to solving the puzzle of aging and death than you might assume.

For thousands of years, wealthy and powerful people have been trying to live forever. We know from clay tablets that 4,000 years ago, the Sumerian King Gilgamesh, after witnessing the death of his best friend, became obsessed with cheating death and living forever. Almost 2,000 years after Gilgamesh, the first Emperor of China, Qin Shi Huang, was so afraid of death that he had anyone who mentioned it in his presence killed. Ironic, no?

Fast forward to the present, and while there’s some debate over whether Peter Thiel is in fact transfusing himself with the blood of the young in an effort to reverse aging, it is a fact that in 2013, Google launched Calico – a firm focused on “solving death”. And just last year, Jeff Bezos helped fund Altos Labs, a company focused on solving aging at the cellular level with the ultimate goal of actually reversing aging.

We finally appear to be on the cusp of the technology to “solve” death, and it’s worth mentioning that while lifespans have been slowly elongating in the developed world for decades, health-spans have not been as impressive. Just because we’re living longer, on average, today doesn’t mean the twilight years have been ones of great or even good health for most. What’s so interesting about this research is that by reversing the aging clock at the cellular level, we not only can potentially extend lifespan, but health-span as well. The technology will enable you to effectively become biologically younger over time until you reach the biologic age you choose and then the process can be stopped (kind of like Benjamin Button with a pause button when you reach your 20’s).

Ray Kurzweil’s book, Transcend, is an interesting corollary to all of this in that in it he proposes the idea of what he calls “a bridge to a bridge to a bridge”. In other words, the technology to extend lifespan ~20 years will be realized within the next ~20 years, and the technology to further extend lifespan an additional ~20 years will then be realized in the subsequent 10-15 years, and then, ultimately, lifespan “escape velocity” will be achieved, whereby the technology to extend life will continually outpace the passage of time. It’s a wild idea and framework, and one that makes sense because it’s based on nonlinear rate of change – a topic I’ve written about in the past.

Back to the Global Macro Grind…

Now that I’ve (hopefully) made you feel just a bit more optimistic about the longer-term future, let me do a quick rug pull and address one of the now many elephants in the room: the subject of today’s Early Look, the Wealth Effect.

To do this properly, I’ll first need to set the stage a bit, and as Trivia often serves an effective stage setter, here we go.

Question: How much US wealth was lost in the first quarter of 2020?

Answer: Total US wealth decline was -$6.3 Trillion. Equity wealth decline was -$7.6 Trillion.

Question: How much US wealth was added from 2Q20 through 4Q21?

Answer: Total US Household wealth (Net Worth) increased by +$40 Trillion in the 7 Quarters from 2Q20 through 4Q21 (to $150.3 Trillion). Equity wealth increased by +$23 Trillion while Housing wealth increased by +$8 Trillion. There was a further +$9 Trillion in increase from direct ownership of private businesses.

So, Covid triggered a 1-Quarter total loss of -$6 Trillion, while the monetary policy response that followed over the next 7-Quarters triggered a collective gain of +$40 Trillion. All told, Net Worth increased by +$34 Trillion, an increase of +36% from the $110 Trillion at the end of Q1 2020. This works out to approximately +26% growth in real terms (in just 7 quarters). For comparison, real wealth grew by 55% in the entire decade of the 1990s and by 43% in the period from 1. In other words, the increase was truly extraordinary. But now we’re on the other side of that.

These figures come from the Fed’s Z.1 Financial Accounts Report – specifically their report on the Changes in Net Worth of Households and Nonprofit Organizations.

Corresponding figures are not yet available for 2022, but we can endeavor to do some back of the envelope calculations.

Since the start of 2022, the Nasdaq Composite is down ~29% while the NYSE Composite is down ~11%. Because the NYSE Composite Index is an odd duck from a construction standpoint, and because the vast majority of the Nasdaq Composite is captured in the S&P 500, we’ll just proxy equity wealth based on S&P 500 YTD returns. That index is down ~18% YTD through last night’s close.

According to the Z.1 report, Directly and Indirectly held stock totaled $50 Trillion at year-end 2021. An 18% reduction amounts to a loss of -$9 Trillion. Direct and Indirectly held debt securities (only those held by Households) amounted to a little over $9 Trillion at year-end 2021. The Barclays Agg Index is down ~9% YTD. That amounts to a loss of ~$800 Billion. Crypto market cap has sunk from a high in mid-November last year of $3.0 Trillion to a current value of $1.3 Trillion. Assuming 30% of that $1.7 Trillion loss is domestic (US = ~30% of Global Wealth), that would equate to an additional loss of ~$500 Billion. Finally, and one of the few rays of good news, Home Prices – according to Redfin – have risen a blistering 12% since the start of the year through mid-May. On a starting value of $38 Trillion, that equates to a gain of +$4.5 Trillion.

Given all of these massive numbers, what does it mean for consumption? That’s an easy question to ask, but a far more difficult one to answer. Why? There are hundreds of academic papers on the Wealth Effect with a huge array of disparate conclusions.

I won’t bore you with all the nuance and complexities associated with the undertaking but trust me when I tell you it’s quite the rabbit hole.

Having read through a fair amount of the academic literature on the wealth effect, the only clear conclusion is that there truly is no clear conclusion.

That being said, a not unreasonable starting point is the annuity-based approach. If a person benefits from a rise in their wealth their propensity to spend that increase is likely to roughly match the spending stream that would be afforded were they to take that increase and purchase an annuity with it. As such, the flow-through rate would be dependent on the person’s age and any plans to bequeath some portion of it. Not surprisingly, this means that the average wealth effect flow through is going to be in the low-to-mid single digit cents on each dollar of incremental wealth.

One paper from the NY Fed (Ludvigson & Steindel) written in the late 1990s made an interesting observation. While their overall observation period of 1 found a 4% spend rate from Stock Market Wealth changes, they observed very different results for the periods 1, 1, and 1. Specifically, they found that from 1 the spend rate was 2.6 cents on the dollar and from 1 it was 2.1 cents on the dollar. But, from 1, the spend rate was a much higher 10.6 cents on the dollar. But why?

Perhaps the answer is inflation. In a high-inflation environment there is a natural tendency to pull forward consumption. In the 1 period, inflation was very low – averaging around 2-3%, while in the 1 period it was similarly in the 3-4% range. But in the 1 period it was a much higher 7-8%. Which of those three sounds like today’s environment?

So the first step is to consider how much consumption was added to the economy in 2021 as a result of the positive Wealth Effect. The $23T increase in Equity Wealth previously referenced broke down as $14T in 2Q20-4Q20 and $9T in 2021. Using the 10.6% figure, and assuming a contemporaneous spend, it would have contributed ~$950B to 2021 consumption, or roughly 4% of GDP. Consider that total real GDP growth in 2021 was 5.8%.

What about the downside? Part of the rabbit hole of academia on Wealth Effect revolves around whether it goes both ways, and if so, does it have the same sensitivity in response to both Wealth increases and decreases. Again, the literature here is frequently in conflict. Some papers suggest the effect is more pronounced in response to Wealth loss than to Wealth gain, while others suggest the effect is more muted.

To keep this from getting unwieldy, let’s assume that it works similarly in both directions.  

At 4% (the effect observed from 1), the $9T decline in equity values would equate to a shave of $360B off of consumption. On a nominal $24T denominator (US Nominal GDP), this would work out to a reduction in growth of around 1.5%. For reference, we’re currently modeling +2.7% real growth in 2022 Y/Y. At the higher 10.6% figure (the effect observed for the 1 period), it would equate to $950B, or 3.95% of GDP. If we assume a comparable debt security and crypto flow through of 10.6%, that would add a further $140B or an incremental 50-60bps of growth slowdown.

Housing wealth creation is potentially an offset, but there are two things to consider here. First, RoC in home prices is slowing dramatically in real time. Consider that just a few months ago, home prices were growing at ~19-20% Y/Y. Since then, however, mortgage rates have risen by more than 2 points. A rough heuristic is that each point increase in mortgage rates reduces affordability (aka, price) by 10%. So, the 2%+ rise in rates should effectively reduce affordability/prices by ~20% or slow the rate of change in home prices from +20% to basically flat.

The second thing to consider is that much of the housing market’s impact on consumption is manifest through cash-out refinancing, which totaled $250B in 2021, up from $114B in 2019. This makes sense as A) rates were ~4% in 2019 and less than 3% in 2021, but today rates are North of 5%. $250B is just over 1% of GDP. So, prospectively this is another area for concern. Who wants to refinance to take out equity when they’re going to go from a 2-3% rate to a 5% rate in the process?

So, putting this all together, we find that the potential for a significant negative Wealth Effect consumption shock – especially when viewed against the massive positive Wealth Effect of 2021 – is an outcome that rises in probability in a positively correlated relationship to the magnitude of the shock itself. In other words, it’s a reflexive function.

The further the market drops, the more likely the Wealth Effect is to take hold. Our current estimate for 2.7% real GDP growth in the US could easily be swamped by these negative Wealth Effect dynamics.

Quad 4 can (and often does) work in mysterious ways. It can reflex on itself to the downside with a vicious feed-forward loop between asset prices and consumption, and the only reason it hasn’t done this more acutely in recent history has been …. drumroll …  the Fed. But this has been possible only because we’ve been in an environment without concomitant inflation challenges.

The problem this time around is, an elevated level of inflation is going to stick around for likely another year and the Fed’s not coming to the rescue any time soon.

Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:

UST 10yr Yield 2.71-2.98% (bullish)
UST 2yr Yield 2.48-2.71% (bullish)
High Yield (HYG) 75.58-77.51 (bearish)            
SPX 3 (bearish)
NASDAQ 11,019-11,883 (bearish)
RUT 1 (bearish)
Tech (XLK) 127-137 (bearish)
Utilities (XLU) 70.30-74.79 (bullish)                                                
Shanghai Comp 3004-3155 (bearish)
Nikkei 25,808-27,066 (bearish)
DAX 13,515-14,240 (bearish)
VIX 26.33-34.29 (bullish)
USD 101.51-105.46 (bullish)
EUR/USD 1.031-1.074 (bearish)
USD/YEN 126.55-130.01 (bullish)
Oil (WTI) 103.46-114.75 (bullish)
Nat Gas 7.66-9.05 (bullish)
Gold 1 (bullish)
Copper 4.06-4.35 (bearish)

To your continued Success,

Josh Steiner
Managing Director