Friday, November 4, 2011

Facts about economy-markets disconnect

Veteran investor Marc Faber has made a very interesting observation in his latest Gloom Boom and Doom report that conflicts this basic principle. Faber agrees that economic and stock market cycles have moved in tandem in the past. But he makes a case for them not being so closely linked in the future. The reason being the concentration of wealth, and liquidity if you will, in the hands of a few. Faber argues that despite poor economic fundamentals in the developed markets, equity and other asset classes may not suffer too much. The premise of this argument is that since the 1980s, wealth inequity has increased significantly. According to him, currently the top 1% percent of households in developed economies earns 20% of all incomes. Also they own 33.4% of the total net worth of these economies. Hence, even though consumer sentiment is controlled by 80% of the population, just 1% of the population controls the money supply and fiscal deficits. The latter in turn largely determine the value of assets and exchange rates. With economic uncertainties like lower income growth and unemployment not impacting the moneyed class too much going forward, Faber believes that equity investing may remain unaffected.

While the logic of Faber's comment cannot be sidelined, we believe that his observation about economy and markets getting disconnected is a theoretical misnomer. For even the 1% population does get affected by the poor sentiment amongst 80% of the population. And when that happens, money supply deserts risky asset classes likes stocks and chases safe returns. At such times most rich households too prefer to maintain their wealth in cash or safe and liquid assets. Hence income inequality may be a reality in developed and developing markets alike. But neither can remain insulated from the downsides of economic cycles by the virtue of wealth concentration.