The K-Shaped Recovery Is A Symptom Of Rising Inequality

The trend of using letters in the analysis of the corona economy continues, this time The Golden Investor discusses the K-shaped recovery and how it affects all us.

After months of discussion, analysis and rumors it is starting to look like we finally got our V-shaped recovery. For how long this stock market recovery will last remains uncertain. Many countries struggle to see pre-corona economic activity. Among the most struggling countries are the United States and the United Kingdom, both countries have had problems containing the COVID-19 spread. Even though economic activity in the U.S. is far below pre-corona levels, stock markets have recovered and the NASDAQ even saw new all-time-highs last month. In Europe stock markets have also recovered, but PMI levels stagnated in August. They even dropped in many countries, suggesting that the current rate of economic recovery could be stagnating. The Purchasers Managers index is a good forward indication of what could be ahead of us. While stock markets thrive, we should not forget that these rallies are a direct result of an unprecedented amount of quantitative easing of central banks and major spending of governments. But as the stimulus packages dry out and government debt surges, it remains questionable if the real economy can leave the financial intensive care.

Figure 1 – PMI Levels Stagnated In August

The Stock Market Recovery

Last few months stock markets have recovered tremendously. The narrative is easy: even though this corona outbreak is temporary, it has boosted many tech companies that offer online services rather than in-person transactions. The idea is that many of these companies will continue to thrive due to permanent shocks, even if all limitations are lifted. However, much of this tech hype is dominated by mega-tech companies. The FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) saw their revenue grow extensively, excluding Google and Facebook whose growth slowed down due to lower ad revenue. However, it are these mega companies that pushed the stock markets up. Investors looking for yield use these stocks as alternative to low yielding safe-havens. The Russell 2000, the U.S. small cap stock index is still -4% percent lower year-to-date. While in the same time Amazon and Apple respectively saw their stock market value grow up to +76% and +59% percent, and even after the latest correction they continue to outperform. These companies even outperformed the largest gold miner Barrick Gold (GOLD), which share price rose significantly after gold hit all-time-highs and was further supported by the Warren Buffet effect; the 90-year-old investor announced it had taken a stake in the company a month ago. When comparing the above mentioned stocks with the NASDAQ and Russell 2000 index, even the NASDAQ-gains look minor.

Figure 2 – Big Tech Outperforms Big Gold

Figure 2 provides a great overview of how insane the latest bull run was and makes the recent correction look minor. There are several explanations for this strange disparity of financial markets with the economic reality. The corona outbreak emergency packages of central banks have supported financial markets and the economy. While at the same time interest rates are locked down at zero creating a favorable environment for new debt issuances, in which especially innovative and funding hungry tech companies tend to thrive. Many companies have issued new debt to lock-in the low interest rates for the long term. Companies use this overflow of liquidity to increase their cash position for the future, even though many business models and revenues are hard hit and still need to recover. Many of this cash flow is directly and indirectly related to the unprecedented amount of quantitative easing of central banks, especially since the FED has increased their balance sheet immensely, buying-up everything from junk bonds to ETF’s. The immense rise of the gold price reflects this unprecedented situation of central bank quantitative easing.

More is yet to come, the euro has appreciated much since the FED announced it changed its inflation target to an average instead of a stable 2 percent. This suggests that inflation is allowed and may overshoot in the future and new quantitative easing could be on the way. The ECB is expected to increase their stimulus package to further support struggling economies, in an effort to depreciate their currency against the dollar to retain a favorable exchange rate to stimulate exports. However, this creates a race to the bottom of central banks, in the end no one will prevail. It is the perfect time to consider stepping into crypto currencies and precious metals as central banks continue to underestimate the inflation of stock markets and real estate prices in their inflation target calculations.

Unemployment Expectations Are Not Looking As Bright

Meanwhile unemployment in the U.S. is still sky high at 8.4 percent, while the Eurozone saw it’s unemployment rise slightly to 7.9 percent. However, these numbers are slightly different from reality since there has been a great outflow of people in the labour force since the start of the pandemic. When accounting those 3.7 million people who left the labour force in the U.S. since the start of the pandemic, the latest unemployment rate number would actually have been 11.1 percent. Moreover, it is important to look at what companies will do to those who currently are on temporary furlough. MGM Resorts announced that they would fire 18.000 employees on furlough in an effort to offset the losses and drop in revenue due to the corona outbreak. Update: Disney (DIS) has also announced to permanently lay-off 28.000 employees after their revenue boosting theme parks remain closed under the coronavirus outbreak.

This corona shock will be the perfect experiment to analyze the different employment laws and policies experiencing simular temporary shocks. The ability to compare the protectionist Eurozone to the more liberal United States has never been as easy as now.

The most open economies in the Eurozone saw the biggest increase in unemployment rates. The Netherlands and Estonia saw its unemployment levels rise 1.1 and 3.3 percent respectively since last year. Open economies outside Europe like Australia and Canada saw their unemployment rise 2.26 and 4.5 percent respectively since last year. Canada’s minor drop in unemployment in July could signify that the road back to pre-pandemic unemployment levels could be longer than expected. Part-time re-employment outpaced full-time hiring in July, showing that companies are not too confident about the future just yet. And as governmental support is slowing down, the K-shaped recovery will eventually become more and more visible, portraying the unsustainable situation in which recovery is only destined for the capital holding and high-educated part of society, while low wage workers stay in economic uncertainty. The BLM-movements are a symptom of the poor trap and the rising income inequality. In a country where wealth defines status this turns into an unbearable situation of societal anger.

The Rise In Inequality Is A Long Run Trend

Since the 1970’s technology has changed the world, but even though productivity rose, hourly wages did not rise as much. The profits of this increased productivity have largely gone to companies and shareholders, while especially low wage workers saw their real wage decline over the decades. This is potentially one of the explanations why stock markets have risen as much as they did the last fifty years.

Figure 3 – Divergence Between Productivity and Hourly Compensation

When taking a further look at wages, the gap becomes even more visible and portrays the current situation in which those at the top saw significantly more increases in annual wages as those not belonging to the top ten percent earners. This divergence can be partially explained by rising globalization in which low educated people have seen competition of low wage workers from other continents, which has led to striking differences within western societies that are unsustainable on the long run.

Figure 4 – Cumulative Change Of The Top 1% Versus The Bottom 90%

The K-shaped recovery is just a symptom of the rise in inequality which has been developing over the last decades. Only this time the situation has come to light like never before, since economic downfalls and upturns in prosperity are experienced differently in these different wage groups. Real change could be made with policies that not only support large profitable companies and their shareholders, but with policies that support both households as struggling (but healthy) companies. Policies should be focused on saving people, not companies. Adding more restraining rules to corporations that use governmental subsidies could safeguard workers and support households. Capital gains of companies should be divided more equally. Currently the capital holding shareholders who had a marginal role in creating corporate profits benefited more than those who actually created these profits, which is something where new policies and laws should aim at more in order to tackle the divergence between different income groups.



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