Crash

Some of the best films are structured such that audiences are compelled to consider the same story from different angles.

That’s often achieved via a collage of seemingly unrelated vignettes which eventually overlap — a serendipitous quilt from a disparate patchwork.

The tale of America as a society of haves and have-nots is especially amenable to multi-dimensional consideration from the vantage point of different economic actors, whose otherwise divergent fortunes invariably and accidentally converge.

In “The Stark Reality Of Modern Stock Market Rallies,” I spent a considerable amount of time editorializing around the notion that households, which own around three quarters of the US stock market through direct holdings, ETFs, mutual funds and retirement accounts, may not be a significant source of equity selling irrespective of the challenging macro environment because most equities held by households are concentrated in the hands of the wealthy. I quoted Goldman’s David Kostin, who called the concentration of equities at the top of the income distribution “astounding.” “Those households are less sensitive to rising inflation,” he wrote.

That’s one side of the story. A vignette of economic privilege. On the other side are lower- and middle-income cohorts, whose experience with inflation is the mirror image of their well-to-do counterparts.

As a general rule, the less money you make, the higher the percentage of your disposable income will go towards necessities like food and gas, the price of which is rising rapidly. This is the so-called “K-shaped” inflation dynamic: Although inflation is a tax on everyone, it disproportionately affects the poor and the middle-class (figure above).

And yet, even as inflation necessarily exacerbates the divergence between the haves and the have-nots, their stories eventually overlap. As Goldman’s Kostin wrote in the same note, “slowing consumer spending represents a greater threat to US equities than households selling their stocks.”

The households which control the vast majority of US stocks are also the households with the lowest marginal propensity to consume. Their incomes vastly outstrip not just the cost of necessities, but also the cost of discretionary purchases and even luxury items, meaning each incremental dollar is far more likely to be saved or invested compared to lower-income cohorts which generally spend every incremental dollar on something. It’s that spending (from the lower- and middle-income groups) which drives the US economy and, in turn, corporate profits. And corporate profits are the main driver of stock prices, alongside buybacks, which are themselves a function of corporate cash flows.

Hopefully, you’re beginning to understand how the stories of the haves and the have-nots converge.

If the have-nots are compelled to dedicate substantially all of their disposable income to necessities due to inflation, that leaves virtually nothing for discretionary spending, which in turn serves as a drag on earnings and, ultimately, the price of the stocks owned by the rich.

“We are seeing the first echoes of household belt-tightening affecting corporate earnings,” Kostin wrote, citing the first decline in retail sales since December (figure on the left, below), record-low consumer sentiment and the well-publicized inventory overhang at major US retailers (figure on the right, below).

If America’s teeming masses (“everyone else,” as it were) stop spending or are constrained in their capacity to drive the economy forward by the necessity of diverting every spare dime to non-discretionary purchases, corporate profits will suffer. Although discounters may fare relatively better, no bottom line is safe in the face of soaring input costs, lingering supply chain snags and rising wage bills.

Goldman called consensus sales and earnings estimates for the Consumer Discretionary sector “overly optimistic, especially if we are headed for a recession.” Kostin branded expectations for double-digit sales growth in the auto industry “Pollyannaish.”

The figure on the right (below) shows the corporate bid for equities around recessions. Falling earnings and higher issuance generally flipped the C-suite from net buyer to net seller.

The figure on the left (above), shows years during which households have been net sellers of equities. During those years, Kostin wrote, “corporates nearly offset household supply.”

But if retrenchment by lower- and middle-income Americans leads to recession and lower corporate earnings, buybacks will suffer. The economic downturn and accompanying profit slump would pile more pressure on stock prices, while the evaporation of net demand from the C-suite would amount to the removal of a natural source of plunge protection. Falling stocks would weigh on the fortunes of the richest households, presumably compelling some to at least consider capitulating, a process that could drive additional downside, in a spiral.

Irrespective of the outcome, the overarching point is that no matter how unequal society becomes, and no matter how divergent our fortunes (figuratively and literally), we can’t escape one another entirely. The reason the film technique described here at the outset is so effective is precisely because it mirrors real life. Our trajectories will invariably overlap, and when things are out of balance, convergence can mean collisions and crashes.

On Goldman’s estimates, real disposable incomes in America are falling at a 6% pace. For now, the bank sees $700 billion of net equity demand from corporates in 2022. The C-suite bought more than a quarter trillion of stock in Q1, the most ever for a single quarter. Last week was the most active week on record for Goldman’s buyback desk.