Anger about economics is widespread in the world today, as evidenced by the rise of populist political movements and politicians around the world. There seems to be a deep sense of distrust in the financial and political systems on the part of the Middle Class and other groups of taxpayers in numerous countries. There have been quite a few recent articles in newspapers and online portals about this, including the Financial Times, The Wall Street Journal, Barron's, and Seeking Alpha. The presidential candidacies of Donald Trump and Bernie Sanders exist because of, and are driven by, different versions of this anger. In fact, it seems to me that these two men are remarkably apt stand-ins for Mark Twain's famous fictional characters, the Prince and the Pauper. One has everything, the other not so much, but they have common goals in a bizarre way: they each want to shake up the system. Whether either will get the chance remains to be seen, but if average Middle Class taxpayers have anything to say about, one of them will. Indeed, famous market analyst Jeffery Gundlach has said recently that if Trump gets the nomination, he will win.
It is my purpose here to discuss why the Middle Class feels increasingly frustrated with politics and economics, and what the potential political and market consequences of Middle Class anger might be, based on what we already observe. In America, many people appear to have a gloomy view of our economic future. Polling from the Pew Research Center, reported by Sam Fleming and Shawn Donnan of the Financial Times, indicates that about 43% of registered voters say conditions are only fair. Another 29% say conditions are actually poor, and only 28% say conditions are good or excellent.
Interestingly, the improving government employment data, gradually rising GDP, and recently rising wages have done little to offset this gloom. As I've pointed out elsewhere, public anger is high enough to support a relatively new and potentially significant tax war on corporations. Part of the Trump phenomenon is due to the candidate's antipathy to US trade deals, which has resonated with many, many voters. There is a feeling on the part of many workers that the trade deals have caused more damage than good. The explanation for voter gloom then would appear to be slow wage growth over many years, perhaps aided or abetted by poor personal employment prospects, according to David Madland at the Center for American Progress. These related factors seem to be more tangible to people than GDP growth or government unemployment data.
Source: Doug Short, dshort.com
I would suggest that there are other factors driving voter gloom and anger as well. For example, although DOL employment data suggest that a very low unemployment rate now prevails (see chart below), the percentage of part-timers is still elevated compared to 2007, and the percentage of full-timers is still depressed compared to 2007, as shown by the chart below from www.dshort.com. We also know that both median and mean real household income has declined since 2000.
Source: Jill Mislinski, dshort.com
While real wages have declined over 15 years, all sorts of Middle Class expenses have increased at high, or even fantastic rates. The primary offenders have been college costs and medical care, whose long-term (since 1978) increases have logged in at an astonishing 1,272% and 670%, respectively. In comparison, CPI inflation is up only 279% over the same period.
The Great Financial Crisis (GFC) triggered a massive wave of older people returning to college, and because of rising costs and stagnant or falling wages, both younger and older students have racked up enormous student loan balances. This may actually pose problems for the economy, because already default rates are setting records, and the loan amounts shown on the chart below are less than half of the total debt.
Source: Jill Mislinski, dshort.com
Donald Trump has argued that free trade deals, as negotiated, have undermined American workers for many years, and he promises to right this wrong. In this case, although he is possibly correct in thinking that Chinese imports have damaged American manufacturing workers and lowered their wages, he is probably incorrect in thinking that trade with China is what's driving US manufacturing job losses in general. The trend of job losses goes all the way back to the 1970s, and has been driven by ever higher productivity, technological advances, and globalization's pressures on the long-term returns to labor. Scott Lincicome has written in the National Review that the US has gained 54 million jobs since 1980, and a full 30 million of them came after NAFTA and the WTO were organized in the mid-1990s.
The US is the world's second-largest manufacturer and third-largest exporter, so the employment issue has been driven mainly by productivity gains, not trade losses. In fact, the Peterson Institute has found that global trade liberalization has generated $7,100 to $12,900 of additional income for the average household. This has not dawned on many people because in their personal lives they just don't see it; instead they see local layoffs and factory closings as tangible proof of job destruction on a local level. The government does not have a good system in place to help workers cope with the local impacts of global trade; indeed, despite many government programs, the best help on offer is welfare for most people. And over 60% of Americans now live paycheck to paycheck.
Curiously, US labor productivity appears to have plateaued in the last few years. This is scary because GDP growth depends on two things: 1) population growth; and 2) productivity growth. The reasons for the slowdown on productivity include inadequate corporate investment despite record profits, low rates, and extremely high age of private nonresidential fixed assets, as has been pointed out by Lakshman Achuthan, COO of the Economic Cycle Research Institute (republished at www.mauldineconomics.com). Again, when average voters see that corporate investments haven't kept up despite what appear to good conditions for investment, it tends to make them cynical about how things work in the economic system. Another possible contributing factor to stalling productivity growth may be the fact that at least a million skilled jobs have not been filled due to a probable lack of qualified applicants. Rather than deal with this like the Germans have (by instituting apprenticeships with intensive training regimes in many fields), most American corporations appear to be lobbying for more H1B visas; this is hardly likely to improve their image on the home front.
US Labor Productivity Has Plateaued:
Income disparities have grown extremely wide under the ministrations of the Federal Reserve, so much so that there has been deep voter anger over it. One issue that resonates with voters is CEO pay, and another is high Wall Street bonuses in the wake of the GFC; these are just two out of a whole list of grievances about the so-called "1%." The wealthy made lots of money courtesy of the Fed, but average workers clearly did not. This adds to the angst about whether government is able or even willing to do anything for the common man anymore.
The claim has long been made that Federal Reserve policies have inadvertently punished retirees and savers, and purposely rewarded the top 10% of income earners who dominate the ranks of retail investors. This was done because of the so-called "wealth effect," a Fed theory that when people feel wealthier they spend more. This was always dubious as a major driving force, but then pretty much everything the Fed says about its reasoning is somewhat dubious. It has moved the goalposts so many times I don't really find its comments either honest or useful in understanding why it does things or why they don't do them. Anyway, they long ago decided that this wealth effect argument served their purposes and they've stuck to it, even though subsequent research by the Fed itself showed that the wealth effect was quite minor in the wake of QE Phases 1, 2, and 3.
The unfortunate byproduct of this adventurism by the Fed has been the growth of a widespread belief that Wall Street would always be taken care of (at Main Street's expense), even though Wall Street was obviously complicit in part for the GFC debacle. Since 2007, the juxtaposition of fiscal authority bailouts (e.g. TARP) and Federal Reserve boosterism for the markets has more or less permanently soured millions of people on the subjects of banks, bankers, markets, Congress, the Administration, and the Federal Reserve.
Now throw in the spreading cancer afflicting most pension funds and retirement accounts, which are falling far short of their goals, and you have recipe for either a move to full-on socialism or a voter revolt. This pension problem has happened because of a weak economy, low contribution rates, low interest rates, negative expected returns on stocks, and potential negative yields on bonds. But wait: there's also the problem of inadequate funding for Social Security, Medicare, Medicaid, and Disability Insurance. How will these be resolved? The same way as always: with tax increases and perhaps some reforms. In the light of all of this, what's surprising to me is not that millions of people favor Trump and Sanders, it's that there have been almost no civil disturbances in spite of huge and relentless provocation. Just wait until the next recession, when nothing government tries works!
But now, to top it all off, the world is experiencing NIRP, with over $7 trillion in bonds already receiving negative yields. Rates are falling nearly everywhere, and they were already insupportably low. Bill Gross recently pointed out that this situation reminds him of Zeno's Paradox (in which the ancient Greek thinker Zeno posed a conundrum about walking with ever-smaller steps towards a goal, which he could never reach because each step was progressively shorter). Somehow, in the real world we know we would actually get to the goal in spite of the mathematical impossibility of it, because our feet will move just enough to get us there. But as Bill Gross explains, NIRP is not going to have a real world happy ending if it continues.
Instead, since all assets are priced off the short-term interest rate, and that yield is zero or negative, then it follows that all asset price growth rates are on their way to zero or below, and soon, if we don't see reflation and a return to normality in the next few months. Want to guess how the general public will react to the simultaneous meltdown of all asset types? We will see behaviors like we're already seeing in Japan (and those of more and more pessimists in the US), e.g., hoarding of cash and gold, the commission of crimes in order to get food and shelter at the government motel, etc. And of course the potential for massive civil disobedience.
Japanese Stock Market Reaction to NIRP:
Source: Doug Short, dshort.com
Investors in the US and elsewhere have played the desperate game of chasing yield for years now, but as Bank of America Merrill Lynch has shown in the chart below, one by one these plays have run into trouble. The current rebound is in my opinion a last chance to get out relatively cleanly. Perhaps there are a few months left to go, but I doubt that there are years left.
Now it seems that the upward mobility the Middle Class has always enjoyed has transformed into something new (but not good), and more and more people have seen, or fear they will soon see, downward mobility taking root in their neighborhoods. If NIRP means Zeno's Paradox now applies to the markets, then how long before many people are forced to wear their very first "pauper" costumes?
The Prince and the Pauper:
In this environment, I do not believe a conventional candidate will win, but if by some mischance they do, they will profoundly regret it. A replay of the 1960s is on tap unless major reforms are seen to be on the way, and soon. Now, some good things happened in the 1960s (e.g., we went to the moon, the Civil Rights Act was passed), but lots of bad things (e.g., riots, assassinations, wars, massive social upheaval) also happened.
What were markets like back then? Interest rates soared in the 1960s. From 1957 to 1966 the Dow Industrials Index doubled, but after 1965 a secular bear market (lasting 16 years) took hold. This had little to do with politics and a lot to do with interest rates and the credit and market cycles, but the political unrest added an element of uncertainty that probably increased volatility.
Dow Jones Industrials Showing Secular Bear Market 1966-1982:
Looking ahead, if the surrogate Prince (Donald Trump) is elected, we will supposedly see major reforms of taxes, healthcare laws, trade laws, immigration laws, possibly the Federal Reserve, and many other things. Markets will dislike the uncertainty associated with potential reforms. However, it seems likely that if all of these wonderful Trumpian promises are kept, the economy will get up, dust itself off, and return to its old growth pattern, at least eventually. So markets will in the long run do better over time. Good sectors to own might be defense (PowerShares Aerospace and Defense Portfolio ETF (NYSEARCA:PPA)), banking stocks (SPDR S&P Regional Banking ETF (NYSEARCA:KRE)), and healthcare stocks (in relief that a liberal didn't get in; Select Sector SPDR Healthcare ETF (NYSEARCA:XLV); Tekla Healthcare Investors CEF (NYSE:HQH)).
On the other hand, if the surrogate Pauper is elected, as I understand it, most things will be free. With an openly socialist president, I would guess that all of the sectors mentioned under Trump would do poorly, so I would in this case short PPA, KRE, XLV, and HQH. What might do well would be tax advisory companies (e.g., H & R Block, Inc. (NYSE:HRB), Intuit, Inc. (NASDAQ:INTU)), hospital networks (e.g., HCA Holdings, Inc. (NYSE:HCA), Community Health Systems (NYSE:CYH), and LifePoint Hospitals, Inc. (NASDAQ:LPNT), and pharmacies (e.g., Walgreens Boots Alliance (NASDAQ:WBA), CVS Health Corp. (NYSE:CVS)). Renewable or green energy should do very well under a President Sanders (e.g., Guggenheim Solar ETF (NYSEARCA:TAN), PowerShares Wilderhill Clean Energy Portfolio ETF (NYSEARCA:PBW)). Under a socialist president I would also expect all of the one-percenters to end up shopping at Wal-Mart Stores (NYSE:WMT), Costco Wholesale Corp. (NASDAQ:COST), or Dollar General Corp. (NYSE:DG)).
In case you haven't noticed, this leaves us with a complete dichotomy, with nearly reciprocal choices depending on who wins in my Prince and Pauper scenario. Good luck to us all.
Disclosure: I am/we are long HQH, WBA, PBW, WMT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks or other securities mentioned or recommended.