More on Markets and Wealth Effects
David R. Kotok,
February 23, 2013



We are scheduled for a half hour with Pimm Fox on Bloomberg TV, Monday, February 25, at 5 PM. We plan to discuss our recent commentary on markets and wealth effects. See for a copy. We are also scheduled for a half hour on Bloomberg radio on Tuesday morning, February 26, at 8 AM with Tom Keene and Mike McKee. I suspect the subject of wealth effects and markets will be on the agenda. We look forward to these discussions on Monday night and Tuesday morning.

Many thanks to readers for the comments on the “wealth effect” piece. Thanks also for the links to other research on this subject. Let’s try to hit a few key points raised in emails.

Liz Webbink, a skilled economist and long-time friend, noted a technical error. I believe, on rereading my text, that she is correct. She suggested a slight change. Many readers do not know that a reduction in debt is an increase in savings. How that debt is reduced is not part of the calculation. So if you pay down your mortgage, your household savings rate rises. And if you sell with a short sale and the mortgage is reduced because a bank takes a loss, your household savings rate also rises.

I wrote, “For the extended, ’93-’12 period, including the financial crisis, the elasticity level reached 0.99. That is, under present circumstances nearly 100 percent of income in the US is spent on personal consumption, when it is adjusted into real terms.”

Liz suggested “For the extended, ’93-’12 period, including the financial crisis, the elasticity level reached 0.99. That is, for each dollar of additional income, 99 cents was spent on personal consumption. Consumers were able to save 5 cents per incremental dollar of income because of the reduction in debt through foreclosures.” Liz also suggested I give readers a link for those who want to delve into this detail. Thank you, Liz.

Readers may find this useful: “A Guide to the National Income and Product Accounts of the United States (NIPA)”. See: .

Some readers asked how high the stock market would have to go to offset the payroll tax hike. That is difficult to estimate, but we will try. Think of it like this. The payroll tax hike is about $125 billion in a permanent shift. If the Credit Suisse elasticity estimates are correct, we would need to multiply that number by about 100 in order to derive the wealth effect needed from stock prices that would offset the reduction of income. That means stocks would need to rise about $12.5 trillion in market value, implying a 60% permanent upward market move.

Of course, that silly calculation assumes there is no change in the housing wealth effect. But we know there would be one, and we have the Credit Suisse estimates that housing has about 3 times the elasticity of stocks. Let’s simplify. A $4 trillion increase in the value of the housing stock would generate about the same consumer spending as a $12 trillion increase in stock prices. Either one would be about enough to offset the $125 billion negative effect of the payroll tax hike.

If we think of the housing stock as worth about the same as the stock market in this post-crisis recovery period, we can estimate a combined housing and stock market outcome. Let’s assume that housing and stocks each start from a present base of around $18 trillion. A crudely estimated 12-15% increase in the national housing stock value and a crudely estimated 25-30% increase in the stock market price level would combine to give us enough positive wealth effect to offset the 2% payroll tax hike.

Now, I hope you can see why the 2% hike delivered to us by President Obama, the Democrats in the Senate and the Republicans in the House was about as dumb a thing as one can conceive.

Dear clients, consultants, professional colleagues, and all readers. At our firm we do not manage policy. We manage portfolios. We do not like this policy of taxing working Americans while engaging in class warfare against wealthy Americans. If we were the czar, we would not do it. But our job is to look at markets and what they will do and why.

The present tax policy combined with very slow growth and cheap money will widen the divide between the rich and poor. If you work and live in America and earn $113,700 or less, you have been kicked in the gut by your president, your senator and your congressman; it makes no difference which political party she or he belongs to. They have all hurt you.

If you have accumulated some wealth, you now face a prolonged period of rising asset prices. Stocks, real estate, precious items, art, collectibles and anything else that benefits from a widening class divide is a target for appreciation. You also face a long period of very low income on your savings. That means you must change the way you invest.

In the very long run this is a terrible policy for America. In the next few years it means a very bullish investment climate.



David R. Kotok, Chairman and Chief Investment Officer
Cumberland Advisors


Category: Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

7 Responses to “More on Markets and Wealth Effects”

  1. ilsm says:

    “We do not like this policy of taxing working Americans while engaging in class warfare against wealthy Americans.”


  2. Moss says:

    I believe the so called class warfare has been waged by the wealthy (political elite, financial elite, corporate elite) against the middle class for the last 25 to 30 years if not longer. To focus only on what is now happening, the talking points, is disingenuous and fails to understand the long term trends in the income and wealth disparities that are the result of previous policies.

    We need fundamental reform of the tax code, individual, corporate and non-profit.

  3. Cooter says:

    If, in the long run, the current policy actions being carried out by our governments and central banks are truly against the interests of all income levels, then surely the most wealthy in society have an obligation to invest a portion of their wealth in ways that offset the abuse of power.

    At what point will asset managers have a responsibility to divert a portion of their client’s savings away from stock and bond markets and into community investment initiatives?

    Why are we not seeing the creation of social enterprise venture capital? Why can’t non-profit ventures be sustainably financed with long term bonds yielding 5%? Surely this yield would be adequate for a portion of a fixed income portfolio? Why are the wealthy not deploying their human capital in ways that generate positive externalities when they know that their current practices harm their long term interests?

    ICI.ORG estimates that there are over $26 trillion in mutual funds assets worldwide. If 1% of that was diverted to financing social enterprises, with 10% of the marginal savings dollars added in every year, the wounds that are hampering the economy would begin to heal, which would feedback into a more prosperous economy, which should drive asset prices higher in a sustainable manner.

    And this could all be done without government being involved. If there are any true capitalists left, then this is what they must do.

    At what point will asset managers cease their ambivalence toward policy and begin working with the wealthy to create sustainable investment vehicles? Surely asset manager fiduciary duty must be called into question when they know that their clients long term interests are not being protected by continuing to invest in this boom bust cycle.

  4. MikeNY says:

    “At what point will asset managers have a responsibility to divert a portion of their client’s savings away from stock and bond markets and into community investment initiatives?”

    Sadly, I don’t see this happening until there is fear of revolution.

  5. bonzo says:

    “If you have accumulated some wealth, you now face a prolonged period of rising asset prices.”

    Sounds lovely, but I think the future tense should be changed to past tense. No reason why stocks/housing must rise more than they have already to offset the payroll tax increase. The more reasonable assumption would be that the payroll tax increase will cause contractionary effects, which would cause stocks/housing to fall. Only to a small extent will these contractionary effects be offset by low rates and more QE. Low rates didn’t help Japan for over 2 decades. Furthermore, the idea that Americans will continue to have low household savings rates forever is also dubious. The boomers are approaching retirement and are underprepared. They will almost certainly start saving aggressively at some point. High savings isn’t unprecedented. Even as recently as the 1980′s, we had much higher savings rates than now. High household savings will also cut earnings. Finally, the rest of the world seems headed for recession, and there go overseas earnings.

    Final result, in my estimate, is to push SP500 earnings down to $90. Pop a 15 multiple on that and you get 1350 for the SP500. And that’s before taking momentum effects into account, and these effects are big in today’s risk-on/risk-off world. I’m down to 30% stocks (my absolute minimum) since October (sold at about 1458) and don’t plan to buy back to my 70% baseline until we dip under 1300. I’ll go all-in if and when we dip under 1200. These targets rise by 6%/year to account for inflation and growth.

    I agree that hanging out in bonds is perfectly safe for now.

  6. Angryman1 says:

    Cooter, the government generally has to be involved at the beginning because in bust cycles, people live in fear.

    If the government would up its investment spending(not like overbloated areas in DoD, corporate subsidies couldn’t pay for most of it with some tax increases), that could get a “conga” line type formation going. Fear declines, the conga party gets going, the government then slips out of the back door without anybody realizing it.

    I see this historical formation even back in the 19th century especially around war. The Civil War era government investment boom to fight the Civil War gets the conga line going, laid the foundation for the American industrialization.

  7. Cooter says:

    Do you see how the wealthy are making their own tax death bed right now?

    They point to current policy actions as a rationale for not investing. Yet as Kotok points out the wealthy are the biggest beneficiaries of the current policies.

    Therefore, if they refuse to use their growing wealth to offset the alleged long run negative policy actions, and instead engage in a de facto capital strike, then they must have their excess wealth taxed so that the government can properly fund the investments society requires.

    The current de facto capital strike by the wealthy is seriously hurting their long run interests, and is providing government and central banks the opportunity to take a growing share of the economy.

    You can’t tell me that today, with the advances in technology across a truly globalized, connected planet that there is too much risk to put a portion of one’s wealth to work investing in enterprises that generate positive externalities. And I don’t mean philanthropy, but rather spurring social innovation through unlocking latent human capital that is abundant across all levels of society. It may sound flaky, but it is a frontier that has only been developed ad hoc thus far. But, it is a frontier that could easily be developed in scale through the wonders of modern finance, if only a few wealthy individuals had the stones to roll the dice to get things going.

    An example of what I am talking about: