Of global equities and equity

On the other hand, global GDP will grow 5.4% between CY2019 and CY2021, implying very low growth in overall household income and possibly contraction in income of vast majority of low-income households.

By Sanjeev Prasad, Anindya Bhowmik & Sunita Baldawa

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The growing divide between ‘income’ and ‘wealth’ raises a controversial point about the role of central banks in exacerbating the ‘divide’. Global market capitalisation has increased around 30% since the start of the pandemic while global GDP (and hence household income) is down. Central banks seem hesitant to ‘exit’ from their ultra-loose monetary policies perhaps fearing ‘taper tantrum’ and bond markets have been beaten into submission—an unhealthy combination.

Growing divide between ‘income and ‘wealth’
Global market capitalisation has increased 31%, bond values have increased on a modest fall in yields and house prices are up since February 15, 2020, broadly the start of the Covid-19 pandemic. This is great news for households who own assets. On the other hand, global GDP will grow 5.4% between CY2019 and CY2021, implying very low growth in overall household income and possibly contraction in income of vast majority of low-income households.

Role of central banks in exacerbating the ‘divide’
Central banks have played a large (if unintended) role in inflation in asset prices through their successful efforts at ‘suppressing’ bond yields (‘target’) through large bond purchases. Even worse, low bond yields have distorted risk perception across asset classes, especially those with no cash flows in the foreseeable future or even in perpetuity, leading to hugely inflated and volatile asset prices. Lastly, central banks are struggling to figure out an ‘exit’ policy from their ultra-loose monetary policies given the negative feedback loop of the market, what we label the 4T trap—talk, target, taper, tantrum (ad infinitum, for now). Any talk of taper results in tremors in markets, leading to central banks to fall back to the status quo of ‘talk’ and ‘target’. Bond markets have become quiescent, perhaps beaten into submission by central banks for now.

Inflation detracts from income, asset inflation adds to wealth
We note that high inflation in the current environment will lead to cuts to real incomes of low-income households, given the sharp decline in incomes from job-losses and disruption to economic activity in physical sectors, which account for a disproportionate share of low-salaried and self-employed workers. On the other hand, high asset-inflation will add to the wealth of asset-rich households. We are not sure about the ‘equity’ of the stated policy of central banks to look through a period of high inflation (transient or structural, only time will tell) while inadvertently ‘encouraging’ asset price inflation.

Taxing ‘hardly-earned’ wealth for some time may not be a bad idea
We see three positives of higher capital gains tax—(1) asset prices may align to levels consistent with earnings and risks rather than levels based on ‘artificially’ low rates (suppressed bond yields), (2) lower speculation, especially in new-fangled asset classes (crypto, SPACs) and (3) higher revenues for governments even if the first two objectives were to fail. Investors worried about the negative impact of higher capital gains tax on entrepreneurship should note that most entrepreneurs would want to retain their stake for a very long time. Long-term investors can stay put while short-term ones can share a portion of their wealth ‘created’ by central banks.

Edited excerpts from Kotak Institutional Equities India Daily report dated June 3

The authors are with Kotak Institutional Equities