"How errors of human judgment can infect even the smartest people, thanks to overconfidence, lack of attention to details, and excessive trust in the judgments of others, stemming from a failure to understand that others are not making independent judgments but are themselves following still others – the blind leading the blind" -Robert J. Shiller
I chose the topic for this month’s Absolute Return Letter during the Christmas break. I sat at home, looking at a pretty bleak world unfolding in front of my eyes and, consequently, asked myself the question – is this it? Has wealth-to-GDP finally begun to mean revert? Some of you will probably argue that wealth-to-GDP has mean reverted for about a year now (which is true), but things definitely took a turn for the worse towards the end of last year with inflation out of control in many countries. Suddenly, it wasn’t only equity markets that struggled. Property prices also started to decline, and property is the biggest driver of household wealth in most countries.
Anyway, to cut a long story short, the first few weeks of 2023 have defied all odds. Equity markets have performed very well, and one is therefore entitled to ask whether the dark thoughts that popped up in my head over Christmas can be justified. Was it all a storm in a teacup? In this month’s Absolute Return Letter, I will look at the arguments for and against.
The latest on wealth-to-GDP
As long-term readers of the Absolute Return Letter will be aware, I follow the ratio of wealth-to-GDP quite closely and have argued for years that (i) wealth cannot continue to grow faster than GDP, and (ii) the ratio must, sooner or later, revert to its long-term mean value. I have always focused on US wealth-to-GDP – not because the underlying theory doesn’t apply in the rest of the world, but because the ratio is more extreme in the US than it is elsewhere. Adding to that, the US has provided trustworthy wealth data since 1951. Other countries don’t even come close to that, meaning that establishing a long-term mean value is somewhat unreliable in many countries.
Now, look at Exhibit 1 below, which has been updated through September 2022 – the December wealth data will be published in March. As you can see, US wealth-to-GDP is off the levels reached in 2021. Since the third quarter of that year, when wealth-to-GDP peaked at 6.17 times, it has fallen quite sharply. As of the latest count (3Q22), the ratio now stands at 5.57 times, i.e. it has declined approx. 10%. However, as I have repeatedly pointed out, the long-term mean value stands at about 3.8 times, i.e. there is still plenty of downside – about 30% to be precise.