Spread Risk: The Investment Implications of Widening Income Inequality

Conclusion: We don’t view the current income disparity in the U.S. as inconsequential; rather we expect to see that contribute to an increase in economic and financial market volatility over the long term as a result of heightened regulatory risk. This is an acute topic to keep in mind over the long-term TAIL.

 

Occasionally, intergovernmental agencies, like the OECD, publish detailed reports and datasets that we find useful in helping shape our big-picture thematic work. Most recently, we took a look at the data and conclusions provided in the OECD’s recent piece on global income inequality. Below we expand upon their baseline analysis to identify the potential investment implications of this international trend.

 

Data & Analysis

The OECD report provided data that shows income inequality generally increasing across the OECD, rising +9.7% over the last ~25yrs, on average, using the Gini coefficient as a standard measure of inequality. On this very measure, income inequality in the United States – which is the third-most unequal country in the survey – increased by +12.1% over the same time period. While not as dramatic as the deltas seen in the Nordic countries, it is a noteworthy delta as far as income inequality is concerned:

 

Spread Risk: The Investment Implications of Widening Income Inequality - 1

 

The OECD’s econometric analysis finds that the international trend in rising income inequality across developed countries was driven largely by changes in the distribution of wages and salaries – on average ~75% of household incomes among working-age adults across the OECD – and the change in hours worked across the socioeconomic distribution. The report finds that demographic trends such as ageing, a +700bps jump in the rate of “assortative mating” (i.e. couples where partners are in neighboring earnings deciles) to 40% on average, and a +500bps increase in the rate of part-time labor to 16% of the total employed population all played a key role in the aforementioned labor market developments.

 

On average, real disposable household income across the OECD grew at a +1.7% average annual rate over the last ~25yrs. The average annual rate of growth for the top decile was, on average, 1.4x times faster than the rate of growth for the bottom decile.  In the U.S., that ratio was 3.9x – meaning the top 10% of wage earners in the U.S. saw their real disposable household income grow nearly four times as fast as those in the bottom 10% over the last ~25yrs.

 

Spread Risk: The Investment Implications of Widening Income Inequality - 2

 

Unlike the OECD average, hours worked did not play a substantial role in perpetuating income inequality in the U.S. In fact, those in the bottom quintile of the U.S. earnings distribution saw their mean annual hours worked increase by +26.2% over the past 20yrs. That compares to a decline of -1.5% for the top quintile and -7.3%/-0.7% across the OECD’s average earnings distribution.

 

Spread Risk: The Investment Implications of Widening Income Inequality - 3

 

Looking at gross incomes across the OECD, which are found to be 34% more unequal than disposable incomes, on average, we see that the top 1% of earners accounted for 9.8% of all income (as of 2008/the latest data) – up +336bps (or +52%) from 1980 levels. The U.S. saw an even more dramatic delta and absolute level of gross income inequality – up +949bps (or +116%) from 1980 levels to a setup whereby the top 1% of earners accounted for 17.7% of all income. Additionally, the share of gross income earned by the top 0.1% of earners increased by a factor of 4x in the U.S. over that timeframe.

 

Spread Risk: The Investment Implications of Widening Income Inequality - 4

 

Spread Risk: The Investment Implications of Widening Income Inequality - 5

 

All told, over the past 2-3 decades, both income inequality and the disparity in work ethic have risen dramatically in the United States relative to other developed economies.  Additionally, the absolute levels of income inequality in the U.S. outpace levels seen in “peer” countries, suggesting that the U.S. may have more downside from a mean reversion perspective should the tide eventually turn – a topic we delve into more deeply in the analysis below.

 

Investment Implications

Among the many derivatives of unmitigated income disparity growth is social instability and/or unrest (i.e. #OWS). If unaddressed for too long, the unstable social pulse may eventually contribute to political and regulatory instability – particularly in democratic societies such as the U.S. (one man; one vote).

 

In a less-tangible form, the data and messaging provided in reports like the OECD’s may perpetuate the social Zeitgeist currently brewing around the U.S. – a Zeitgeist that is built upon feelings of resentment towards higher income earners, as well as a gut feeling that the “game is rigged” in favor of the wealthy elite.  Moreover, as constituents become more disgruntled, they are likely to demand that their elected representatives pursue protectionist measures, anti-globalization reforms, as well as additional oversight of the financial industry – the opposite of each are traditionally deemed as key contributors to income inequality in the developed world (though the OECD report claims to exonerate the former two).

 

As an aside, Chuck Schumer’s “anti-China” trade bill (S 1619) is an example of protectionist legislation currently being debated on by policymakers that could garner increasing support in the coming quarters. Refer to our recent note for more details. Obama’s “millionaire’s tax” idea and a potential rhetorical shift towards bad-mouthing the financial services industry – a strategy we contend he could pursue (like FDR did) if needed to galvanize populist support in the coming months – are to examples of real policy debates becoming increasingly focused on the heavily-skewed income distribution and financial services oversight.

 

While we have chosen to withhold our own opinions of what we think is the right mix of policy strategies to pursue for the country’s long-term economic and social prosperity (yes, both matter when policy is being designed), we do think that a shift in D.C. towards the aforementioned strategies is, on the margin, destructive to the U.S.’s 2012-15 economic outlook (and potentially beyond). Additionally, absent a major improvement in domestic labor market conditions, we can be all but assured some mix of regressive policy is likely to be pursued with increasing popular support – particularly if reports demonstrating inequality and unfairness continue to gain coverage at accelerating rates. The following articles demonstrate a shift of the reporting of popular skepticism and conspiracy theories away from lesser-known channels to larger media outlets:

All told, we don’t view the current income disparity in the U.S. as inconsequential; rather we expect to see that contribute to an increase in economic and financial market volatility over the long term as a result of heightened regulatory risk. This is an acute topic to keep in mind over the long-term TAIL.

 

Long live the principles of Transparency, Accountability, & Trust.

 

Darius Dale

Analyst


Cartoon of the Day: Bulls Leading the People

Investors rejoiced as centrist Emmanuel Macron edged out far-right Marine Le Pen in France's election day voting. European equities were up as much as 4.7% on the news.

read more

McCullough: ‘This Crazy Stat Drives Stock Market Bears Nuts’

If you’re short the stock market today, and your boss asks why is the Nasdaq at an all-time high, here’s the only honest answer: So far, Nasdaq company earnings are up 46% year-over-year.

read more

Who's Right? The Stock Market or the Bond Market?

"As I see it, bonds look like they have further to fall, while stocks look tenuous at these levels," writes Peter Atwater, founder of Financial Insyghts.

read more

Poll of the Day: If You Could Have Lunch with One Fed Chair...

What do you think? Cast your vote. Let us know.

read more

Are Millennials Actually Lazy, Narcissists? An Interview with Neil Howe (Part 2)

An interview with Neil Howe on why Boomers and Xers get it all wrong.

read more

6 Charts: The French Election, Nasdaq All-Time Highs & An Earnings Scorecard

We've been telling investors for some time that global growth is picking up, get long stocks.

read more

Another French Revolution?

"Don't be complacent," writes Hedgeye Managing Director Neil Howe. "Tectonic shifts are underway in France. Is there the prospect of the new Sixth Republic? C'est vraiment possible."

read more

Cartoon of the Day: The Trend is Your Friend

"All of the key trending macro data suggests the U.S. economy is accelerating," Hedgeye CEO Keith McCullough says.

read more

A Sneak Peek At Hedgeye's 2017 GDP Estimates

Here's an inside look at our GDP estimates versus Wall Street consensus.

read more

Cartoon of the Day: Green Thumb

So far, 64 of 498 companies in the S&P 500 have reported aggregate sales and earnings growth of 6.1% and 16.8% respectively.

read more

Europe's Battles Against Apple, Google, Innovation & Jobs

"“I am very concerned the E.U. maintains a battle against the American giants while doing everything possible to sustain so-called national champions," writes economist Daniel Lacalle. "Attacking innovation doesn’t create jobs.”

read more

An Open Letter to Pandora Management...

"Please stop leaking information to the press," writes Hedgeye Internet & Media analyst Hesham Shaaban. "You are getting in your own way, and blowing up your shareholders in the process."

read more