2010 is a watershed year in China’s macro-economics. This is the year when China transcended its Lewis Turning Point and Kuznets Turning Point. It is the year of twin inflection points, at which the inexpensive rural labor started to get exhausted, and four decades of “Reform and Open” had culminated in rapid economic growth lifting enough people out of pauperism, a time when inequality started to alleviate. From this point, China’s urbanization, demographics, inequality, and the secular trend in the stock market all started to shift. Now, with “Common Prosperity” being the dominant theme in China, one must ponder how best to position one’s investment portfolio in this new milieu.
We use income disparity as a proxy for measuring social inequality and thus the level of common prosperity. Inequality affects stock market performance via its impact on interest rates. A society with acute inequality must be a surplus society, as the rich earns more than it can consume, while the poor doesn’t earn enough proportional to their output to finish all the excess supply. Such a glut depresses inflation and thus interest rates, and vice versa. As such, as equality improves, inflation and interest rates should rise in tandem. And the change in interest rates is the key to stock returns. We have constructed our proprietary market and sectoral indices over 100 years to learn from the US experience. Between 1950s and 1980s, inequality in the US fell precipitately; inflation and interest rates rose; materials, energy, communications, infotech and healthcare outperformed. In China’s on- and off-shore markets, infotech, healthcare and staples have done well after the 2010 inflection.
“Common Prosperity” has been a consistent theme in China’s development goal, and has indeed been entrenched in ancient classical Chinese philosophy. If China’s social structure is a product of deliberate policy intent, then the inception of declining inequality in the US between 1950s and 1980s may be an accident. As Roosevelt signed the G.I. Bill of Rights to provide funding for education and housing for the 12 million returning military personnel to stop them from entering the job market to depress wages, the US in fact had accumulated tremendous human capital and initiated social mobilities across different social echelons. This ushered in Lyndon Johnson’s “Great Society” in the 1960s. Coupled with technology progress from war spending, this period laid the foundation for the US for the ensuing 60 years. We can see familiar elements towards China’s goal of Common Prosperity from the US experience: higher education, home equity, safety net from healthcare, technology advancement and the government’s strong intent. By 2020, China had eliminated poverty, a full decade ahead of the UN’s goal. It is time to set our sight higher toward Common Prosperity, and position our investment accordingly for this dominant macro theme for the next decade.