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There may be no contrarian question with more potential to upend the US investment paradigm than this: What if US wealth inequality were to reverse?
For decades, rising inequality has shaped the US economy and, by extension, investment returns. Now, many of the factors that have long contributed to inequality are shifting, from monetary policy to globalization to organized labor. A reversal of inequality would have deep, far-reaching ripple effects across asset classes.
Some of our experts have been outlining a US macroeconomic regime shift for some time now. In these efforts, they’ve dissected the concentration of capital among a select few mega-cap tech stocks, inflation, interest rates, the rise of passive rather than active management, and more. Now, we believe it’s time to consider wealth inequality, another economic hallmark of the post-global financial crisis (GFC) period in the US and elsewhere.
Wealth inequality has been an ongoing concern among pundits, politicians, academics, financial analysts, and more for years. It’s a potential systemic threat to US stability both politically and economically. The reasons for global economic inequality over the past three decades are many:
As some of these global trends unwind and reverse, is it possible that wealth inequality could do the same?
It’s possible that a reversal of wealth inequality may have begun before the COVID-19 pandemic and accelerated in the time since. Labor supply appears likely to be structurally constrained moving forward, particularly in developed markets (a podcast from our colleagues Juhi Dhawan and Nick Wylenzek explores this topic in-depth), spiking labor’s negotiating power. Meanwhile, decarbonization and deglobalization efforts have intensified worldwide, which should trigger greater fiscal and corporate investment in tangible assets. What’s more, we’ve entered a regime of higher nominal rates which could see the transfer of wealth from the Fed and banks to consumers. If a reversal of wealth inequality were to come about, there would be significant market and investment implications. A reversal could undergird persistent inflation or alter consumer spending patterns. In our view, it’s not too early to consider the possibility of an inflection point.
For some time now, we’ve theorized that consumer spending resilience could surprise to the upside in the face of high and rising interest rates, a notion which has not necessarily aligned with broad consensus expectations. But, in our view, the narrative around the low-end consumer is misguided, if not wrong. For years, policy changes and the like have tended to benefit top earners, often to the detriment of the lower quintiles of earners. While the top 5% is always going to be better off than the bottom 20%, the relative fortunes of these cohorts may have reversed in the past few years.
For example, consider real estate, which has been on a tear for the past decade, but saw prices accelerate to new highs during the pandemic. The net effect of higher rates is a positive cash flow development for the household sector in aggregate. This is most powerful for the top-income quintile, but also net positive for the lowest-income quintile. Among this group, 60% of wealth is in real estate, so it’s possible that lower-income homeowners may have benefitted from the recent real-estate sector dynamics. We think this is important and if the status quo remains, the net interest income flowing to these household may be set to grow.
While, of course, wealth inequality undoubtedly exists and an ultra-wealthy few have a far more advantageous economic stronghold than the lowest quintile of earners, perhaps some progress has been made. The question now: Is this progress sustainable?
There are several things to consider in trying to answer this question. Real estate will obviously be a determining factor. Some analysts predict a major pullback in home prices, if not a collapse. However, we maintain the conviction that home prices could surprise to the upside given a significant supply/demand imbalance and argue that the US may be short more than a million single-family homes. It’s worth noting, however, that price appreciation has slowed under the weight of higher interest rates and home prices have been flat since June 2022. We expect this resilience to continue, with only a slight decline in home prices through the end of 2023.
Meanwhile, we expect wage inflation to continue bolstering low-end consumer spending power. In recent years, the rate of wage growth among workers with a high school degree versus a four-year college degree have come into parallel. Previously, wage growth tended to be higher among college-educated employees.1 There’s good reason to believe that this trend will continue.
Additionally, labor shortages persist across many industries. As of the end of 2022, the leisure and hospitality industries were still down more than 50,000 workers compared to February 2020.2 In durable goods manufacturing, wholesale and retail trade, education, and health services, there are more unfilled job openings than unemployed workers with experience in their respective industry. In fact, even if every single unemployed person with experience in the durable goods manufacturing industry were employed, 25% of the available jobs in this industry would remain unfilled.3
The resurgence of organized labor could buoy middle and low-end worker wages. In fact, de-unionization has accounted for roughly a third of the growth in the wage gap between high- and middle-income workers since 1979.4 As labor has gained negotiating power in recent years, we see a corresponding uptick in union membership and “major work stoppages.” This momentum appears to be increasing in 2023, headlined by the writers’ and actors’ strike in the entertainment industry and by the massive United Auto Workers strike — both explicitly undergirded by inequality-driven grievances that top executives (and the biggest celebrities, in the case of the entertainment industry) are taking home too big a piece of the total pie. Today, 71% of Americans approve of unions — the highest approval rating since 1965.5
For roughly 30 years, the growing wealth divide has seemingly been an unstoppable force. Many of the driving factors remain in place. Industry consolidation is still at historic extremes. Digitization continues to rapidly progress, and artificial intelligence (AI) threatens to accelerate automation to new heights, creating fear for labor's future negotiating power. Moreover, a presidential election looms in 2024 and one way or another, the outcome will have implications for the future of US wealth inequality.
This said, evidence is mounting that we've reached an inflection point. The wealth divide could continue contracting for years to come. It could alter the political dynamics of the nation. It could shift the nature of demand for goods and services. And it could challenge investment assumptions across asset classes. Households entered each successive recession from 1980 to 2008 with a weaker balance sheet. Following the GFC, the opposite has been true. This has major ramifications for investing and for the economy.
The implications of reversing inequality are too wide to cover in a single article, but there are some that stand out:
1 Federal Reserve Bank of Atlanta, August 2023. | 2 The Washington Post, "Restaurants can’t find workers because they’ve found better jobs," 3 February 2023. | 3 US Chamber of Commerce, "Understanding America’s Labor Shortage: The Most Impacted Industries," 10 August 2023. | 4 Economic Policy Institute, "The erosion of collective bargaining has cost middle-wage workers thousands of dollars each year," April 2021. | 5 Gallup, "U.S. Approval of Labor Unions at Highest Point Since 1965," 30 August 2022.
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