Economists and market participants have introduced increasingly sophisticated models over the past half-century to explain the ups and downs of the stock market.With some adjustments in corporate earnings measures and risk free pricethese methods describe the movement of the market very well.
But there is an easier way to explain stock movements. What if we ignore their economic nature and think of them as high-end consumer goods, such as luxury watches, priced by the forces of supply and demand?
![subscribe button](https://i0.wp.com/blogs.cfainstitute.org/investor/files/2019/01/Subscribe-Button-1.png?resize=640%2C270)
Abraham Maslow’s theory puts stocks high Hierarchy of Human NeedsSimply put, buy stocks only after reviewing shelter, food, transportation, education and other more pressing concerns. The higher your income, the more freely you can invest in stocks and vice versa.
Based on this perspective, income inequality is a hidden driver of stock prices. In a highly egalitarian society, there will be less demand for stocks. why? Because the need for shelter and consumer goods trumps the need to own stocks. Suppose 20 households earn $50,000 a year and one household earns him $1,000,000. According to our researchthe demand for stocks of the latter households is almost 20 times higher than that of the other 20 households combined.
While the traditional financial stock performance model is still valid, there is another explanation for the 40-year secular bull market based on the 19th-century law of supply and demand.
On the demand side, rising income inequality mechanically boosts demand for equities and returns along with it. On the supply side, net share issuance has been weak since the US Securities and Exchange Commission (SEC) legalized share buybacks in 1982.
Classical economics explains what happens when the demand for a good rises faster than its supply. Real prices of goods must riseThus, the prolonged bull market that began in 1982 was a direct result of a combination of strong demand growth, fueled by rising income inequality, and sluggish supply, among other factors. bottom.
Analysis shows that the real price return for the S&P 500 during the bull market from 1982 to 2021 was 6.9% annually. This is 6.2% better than the 0.7% per year that occurred between 1913 and 1982.
What explains the difference? We can see that 2.4 percentage points of the excess returns came from some kind of sea change. Income equality was on the rise in his late 1970s and early 1980s, but then the tide turned and then rising income inequality became the norm.
An additional 1.4 percentage points of excess price return is due to the tight supply caused by the 1982 SEC share buyback decision. The rest is due to higher equity allocations, lower inflation and lower interest rates, among other various factors.
What if the world were different? The real price of the S&P 500 in 2021 would be very different if the income inequality trend hadn’t reversed and the SEC hadn’t allowed share buybacks. We illustrate these dynamics by focusing on the real price change of a $10,000 investment made in the S&P 500 through 1982 and realized through 2021.
The result of a $10,000 investment made in 1982 and realized in 2021
(1982 Average Real S&P 500 Price Index: 317)
Buyback as-is
predict | inequality as it is | negative inequality stop trend 1982 |
negative inequality trend continuation since 1982 |
Full dividend reinvestment |
$315,000 | $193,000 | $133,000 |
No dividend reinvestment |
$134,000 | $81,000 | $56,000 |
average real S&P 500 Price ($2021) |
4,261 | 2,581 | 1,764 |
Pre-1982 Buyback
predict | inequality as it is | negative inequality stop trend 1982 |
negative inequality trend continuation since 1982 |
Full dividend reinvestment |
$315,000 | $193,000 | $133,000 |
No dividend reinvestment |
$81,000 | $49,000 | $33,000 |
average real S&P 500 Price ($2021) |
2559 | 1540 | 1047 |
The market would have risen in all scenarios. However, there is a big difference between his 230% rise in the S&P 500 in the worst case scenario and his 1240% rise in the real world. Income inequality is therefore not the whole story of stock market performance, but it is an important factor that has not been seen before.
What does this mean for the future viability of a long-term bull market?
Certainly, periodic headwinds will have an impact at times, as we’ve seen over the past year or so. But rising income inequality will keep the stock market moving unless a different decision is made at the ballot box.
If you like this post don’t forget to subscribe enterprising investor.
All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect those of CFA Institute or the author’s employer.
Image credit: ©Getty Images / Zorica Nastasic
Professional Learning for CFA Institute Members
Members of CFA Institute are empowered to self-determine and self-report the professional study (PL) credits earned, including: enterprising investorMembers can easily record credits using credits. Online PL Tracker.