Global Imbalances and Flaw of Averages
Ajay Kapur et. al. of Citigroup Global Markets in an Equity Strategy Report: "Revisiting Plutonomy: The Rich Getting Richer" [March 2006].
Also wealth inequality isn't necessarily a major problem for a country. The lack of law and fairness is.
[Update 9/5/06] Read the full report today. Though the logics for authors' "conclusions" are not always straightforward to me, there are still some useful points, which may explain why the US economy has been so resilient for the last few years, a conundrum I have had hard time to explain myself.
The authors used a chart to show that the plutonomy index have handsomely outperformed the Global Equity Market Index since 1985, hence we should buy the plutonomy stocks. My observation, however, is that the outperformance is largely correlated with the long-term up trend since then, i.e., there are more good times than bad and that the plutonomy stocks outperform the whole market when markets are doing well. If you look at the bear periods, e.g., 1987, 90, 98, and 2000-2002, they tend to perform worse than the Global index. My points are that (1) the plutonomy is not a predictor for continuing equity market; thus (2) we still should be vigil to any signs of possible market clapse that no one, rich or not, can be immuned from. The author's use of relative strength of plutonomy vs world market index as a predictor is not convincing either, e.g., it failed to predict the market clapse in year 2000. It rather is an after-effect.
The authors' use of LVMH (LVMH.PA), the company that sells Luis Vuitton luxury goods and of which Citigroup is a shareholder, as an example for plutonomy stocks doesn't help their argument either. Just after their report, the stock of this company has dropped from euro 85 to around 70, breaking its long-term up-trend. This kind of volatility is not what most investors wouldn't like to see. The same may be said of the Report's another recommendation: Richemont (CFR.VX), which has dropped from 65 to around 53 at one point.
[Update #2, 9/5/06] Incidently there is an article on Yahoo Finance that is related to wealth creation: Lying is Easy, Wealth Takes Work. Some notes from the article (notice the three 'L' words):
“The World is dividing into two blocs - the Plutonomy and the rest. The U.S.,UK, and Canada are the key Plutonomies - economies powered by the wealthy. Continental Europe (ex-Italy) and Japan are in the egalitarian bloc.”Although I am not surprised with the findings and the limitation of using averages is well known among statisticians, the implications cannot be overstated: be careful with using the average numbers in interpreting daily economic news and judging the state of a nation's economy.
“The top 1% of households in the U.S., (about 1 million households) accounted for about 20% of overall U.S. income in 2000, slightly smaller than the share of income of the bottom 60% of households put together. That’s about 1 million households compared with 60 million households, both with similar slices of the income pie! Clearly, the analysis of the top 1% of U.S. households is paramount. The usual analysis of the “average” U.S. consumer is flawed from the start. To continue with the U.S., the top 1% of households also account for 33% of net worth, greater than the bottom 90% of households put together. It gets better (or worse, depending on your political stripe) - the top 1% of households account for 40% of financial net worth, more than the bottom 95% of households put together.”
“Since consumption accounts for 65 pct of the world economy, and consumer staples and discretionary sectors for 19.8 pct of the MSCI AC World Index, understanding how the plutonomy impacts consumption is key for equity market participants.”
“There is no “average consumer” in a Plutonomy. Consensus analyses focusing on the “average” consumer are flawed from the start. The Plutonomy Stock Basket outperformed MSCI AC World by 6.8% per year since 1985. Does even better if equities beat housing. Select names: Julius Baer, Bulgari, Richemont, Kuoni, and Toll Brothers.”
“The drivers of plutonomy in the U.S. (the UK and Canada) are likely to strengthen, entrenching and buttressing plutonomy where it exists. The six drivers of the current plutonomy: 1) an ongoing technology/biotechnology revolution, 2) capitalist-friendly governments and tax regimes, 3) globalization that re-arranges global supply chains with mobile well-capitalized elites and immigrants, 4) greater financial complexity and innovation, 5) the rule of law, and 6) patent protection are all well ensconced in the U.S., the UK, and Canada.
They are also gaining strength in the emerging world. Eastern Europe is embracing many of these attributes, as are China, India, and Russia. Even Continental Europe may succumb and be seduced by these drivers of plutonomy.”
“Equity risk premium embedded in “global imbalances” are unwarranted. In plutonomies the rich absorb a disproportionate chunk of the economy and have a massive impact on reported aggregate numbers like savings rates, current account deficits, consumption levels, etc. This imbalance in inequality expresses itself in the standard scary “global imbalances”.
Also wealth inequality isn't necessarily a major problem for a country. The lack of law and fairness is.
[Update 9/5/06] Read the full report today. Though the logics for authors' "conclusions" are not always straightforward to me, there are still some useful points, which may explain why the US economy has been so resilient for the last few years, a conundrum I have had hard time to explain myself.
... the rich are such a massive part of the economy, that their relative insensitivity to rising oil prices makes US$60 oil something of an irrelevance. For the poorest in society, high gas and petrol prices are a problem. But while they are many in number, they are few in spending power, and their economic influence is just not important enough to offset the economic confidence, well-being and spending of the rich.Their conclusions for equity investors? Stay positive. Buy "plutonomy stocks" - companies that sell to rich people.
... the rich are feeling a great deal happier about their prospects, than the “average” American. And as the rich are accounting for an ever larger share of wealth and spending, it is their actions that are dictating economic demand, not the actions of the “average” American.
[On] the dollar. The perma-bears told us that the current account deficit in the US was too high. It could only be lowered by raising the savings rate of the household sector which inturn would only be accomplished by rising interest rates and/or a dollar collapse.We disagree. [On the contrary] ... following the dollar’s more than 50% devaluation against the Euro between Nov 2000 and Nov 2004, The bilateral trade deficit (on a rolling 12 month total basis) nearly doubled! The bottom line to us is that plutonomics is a better explanation of these ‘nasty’ deficits, and currency manipulation just doesn’t change the habits of plutonomists enough to make a difference.
The authors used a chart to show that the plutonomy index have handsomely outperformed the Global Equity Market Index since 1985, hence we should buy the plutonomy stocks. My observation, however, is that the outperformance is largely correlated with the long-term up trend since then, i.e., there are more good times than bad and that the plutonomy stocks outperform the whole market when markets are doing well. If you look at the bear periods, e.g., 1987, 90, 98, and 2000-2002, they tend to perform worse than the Global index. My points are that (1) the plutonomy is not a predictor for continuing equity market; thus (2) we still should be vigil to any signs of possible market clapse that no one, rich or not, can be immuned from. The author's use of relative strength of plutonomy vs world market index as a predictor is not convincing either, e.g., it failed to predict the market clapse in year 2000. It rather is an after-effect.
The authors' use of LVMH (LVMH.PA), the company that sells Luis Vuitton luxury goods and of which Citigroup is a shareholder, as an example for plutonomy stocks doesn't help their argument either. Just after their report, the stock of this company has dropped from euro 85 to around 70, breaking its long-term up-trend. This kind of volatility is not what most investors wouldn't like to see. The same may be said of the Report's another recommendation: Richemont (CFR.VX), which has dropped from 65 to around 53 at one point.
[Update #2, 9/5/06] Incidently there is an article on Yahoo Finance that is related to wealth creation: Lying is Easy, Wealth Takes Work. Some notes from the article (notice the three 'L' words):
... one of the biggest lies people tell themselves about investing is that it's risky. Investing isn't risky -- being incompetent and lazy is risky.
[Do not blame on others. ] "There are no bad soldiers, only bad leaders."
Mutual funds are for losers. Over 40 years, most mutual fund companies retain approximately 80 percent of the gains while investors receive a paltry 20 percent. Investors also put up 100 percent of the capital and take 100 percent of the risk.
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