Economists and market participants have introduced increasingly sophisticated models over the past half-century to elucidate 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.
But there’s a less complicated strategy to account for a way equities behave. What if we de-emphasize their financial nature and consider them as high-end consumer goods — luxury watches, for instance — whose prices are determined by the forces of supply and demand?
Equities occupy an elevated position in Abraham Maslow’s hierarchy of human needs. Simply put, we buy stocks only after we have now seen to our shelter, food, transportation, education, and other more immediate concerns. The upper our income, the freer we’re to speculate in equities, and vice versa.
Based on this attitude, income inequality becomes a hidden driver of equity prices. In a really equal society, equities are less in demand. Why? Because the necessity for shelter and consumer goods trumps the necessity to own stocks. Imagine 20 households each have annual incomes of $50,000 while a single household has $1,000,000. In keeping with our research, the latter household’s demand for equities is almost 20 times that of the opposite 20 households combined.
While traditional finance’s equity performance models still work, there’s another explanation for the 40-year secular bull market based on nineteenth century laws of supply and demand.
On the demand side, rising income inequality mechanically drives equity demand up and with it, returns. On the availability side, net share issuance has been anemic ever for the reason that Securities and Exchange Commission (SEC) legalized share buybacks in 1982.
Classical economics explains what happens when demand for rises faster than its supply: The true price of the great must increase. Thus, the secular bull market that began in 1982 has been the direct consequence of strong demand growth fueled by ballooning income inequality, amongst other aspects, combined with supply that has not kept up.
The S&P 500’s real price return in the course of the 1982 to 2021 bull run was 6.9% per yr, in line with our evaluation. That’s 6.2 percentage points higher than the 0.7% generated annually between 1913 and 1982.
What explains that difference? Of the surplus return, we discover that 2.4 percentage points stems from a sea change of sorts. Income equality was on the rise within the late Seventies and early Eighties, but then the tide turned and increasing income inequality has since grow to be the norm.
One other 1.4 percentage points of the surplus price return results from the availability squeeze brought on by the 1982 SEC’s decision on share buybacks. The remainder is as a consequence of growing equity allocations, lower inflation, and lower rates of interest, amongst various other aspects.
So what if the world had been different? 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. We express these dynamics by specializing in the true price evolution of a $10,000 investment made throughout 1982 within the S&P 500 and realized throughout 2021.
Final result of a $10k Investment Made in 1982 and Realized in 2021
(Average Real S&P 500 Price Index in 1982: 317)
Buybacks as Is
| Assumption | Inequality as Is | Negative Inequality Trend Stopped in 1982 |
Negative Inequality Trend Continued since 1982 |
| Dividends Fully Reinvested |
$315k | $193k | $133k |
| Dividends Not Reinvested |
$134k | $81k | $56k |
| Average Real S&P 500 Price (in 2021 Dollars) |
4,261 | 2,581 | 1,764 |
Buybacks as Before 1982
| Assumption | Inequality as Is | Negative Inequality Trend Stopped in 1982 |
Negative Inequality Trend Continued since 1982 |
| Dividends Fully Reinvested |
$315k | $193k | $133k |
| Dividends Not Reinvested |
$81k | $49k | $33k |
| Average Real S&P 500 Price (in 2021 Dollars) |
2559 | 1540 | 1047 |
The market would have risen in all scenarios. But there’s a serious difference between the S&P 500’s 230% increase in essentially the most bearish scenario and its 1240% actual increase. So, while income inequality shouldn’t be the be-all and end-all of stock market performance, it’s a critical factor that was previously hidden from view.
What does this mean for the secular bull market’s future viability?
To be certain, cyclical headwinds will play a job at times, as they’ve over the past yr or so. But rising income inequality will proceed to propel equity markets unless and until the ballot box decides otherwise.
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All posts are the opinion of the writer. As such, they shouldn’t be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the writer’s employer.
Image credit: ©Getty Images / Zorica Nastasic
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