For Main Street, A Deeply Depressing, Wholly Pyrrhic Victory

Main Street scored a rare “win” over Wall Street in 2022.

I’m not sure that’s the best way to think about things as an abysmal year for markets winds down, but it’s one interpretation of a large decline in the ratio of financial assets to GDP.

The figure (below) depicts financial assets held by the private sector relative to total US economic output. When you consider that the vast majority of corporate equities (for example) are concentrated in the hands of a relative few households, you can certainly argue that the drop in what amounts to leverage does indeed represent Main Street “outperformance.”

The ratio was much lower in a bygone era of labor bargaining clout, far narrower CEO-to-worker compensation gaps and prior to the socioeconomic shift ushered in by the Reagan Revolution, which I’d argue doesn’t deserve to be celebrated, at least not as it relates to economic policy and attitudes towards corporate profits, which, to this day, are still considered sacrosanct in America.

For younger readers, I’d note that very much contrary to what some conservatives would have you believe, it was in fact the Reagan administration which did away with budget discipline in America. It was Bill Clinton who reclaimed that lost discipline with the inadvertent (and somewhat dangerous) side effect that the juxtaposition between the Clinton boom and subsequent budget surpluses led (too) many observers to harbor counterintuitive ideas about the fiscal multiplier.

I digress. The chart is from BofA’s Michael Hartnett, who explained the situation in straightforward terms. “Main Street outperformed Wall Street in 2022 as the ratio of financial assets to GDP dropped from 6.2x to 5.4x as wages rose and asset prices slumped,” he wrote, in the latest installment of his popular weekly “Flow Show” series.

If it was a victory for Main Street, it was of the Pyrrhic variety. Deeply negative real wage growth and the sky-high inflation responsible for falling real pay meant most on Main Street wouldn’t describe 2022 as any sort of “win” for everyday people. Just ask the University of Michigan sentiment survey.

In 2023, Main Street may have even more to worry about than inflation which, according to the Fed’s own forecasts, will still be very elevated relative to what Americans have come to know over the past two decades. BofA’s Hartnett warned of a hard landing for the real economy next year, as the lagged effect of tight monetary policy (figure on the right, below) “drives mean reversion” across a variety of key Main Street macro metrics (figure on the left).

The unemployment rate is “abnormally low,” Hartnett remarked. It’s averaged 6.2% over the past half-century, while the 2.3% personal savings rate bears no resemblance to the six-decade average of 9%, nor does the 2.1% credit card delinquency rate reflect the historical mean, which is nearly twice as high.

At the same time, BofA wondered how sustainable the 1.5% corporate default rate is, considering the average was 3.8% since 2005.

When it comes to the realization of a hard landing on Main Street, it can’t come fast enough for Wall Street. “[The] quicker the labor market breaks, the quicker end to the bear market,” Hartnett went on to say, adding that BofA still expects a “shadow banking credit event” to mark the “Big Low in 2023.”