The ‘Gini’ is out of the bottle

Recession proof (?) 

Recent global equity market price momentum has been strong despite ongoing policy uncertainty, escalated military conflict in the Middle East, and lower consensus economic growth forecasts. A US recession – a scenario which might lead to a significant shift in asset price performance – remains a low probability event. A lot of observers find this puzzling. Since the pandemic, real disposable income growth has been anaemic in aggregate (less than 1% per year compared to 2.8% annualised over the past 50 years). There has been a considerable tightening of monetary policy which has made life more difficult for borrowers - the average 30-year mortgage rate is at 6.75%, compared to 3% before the Fed raised rates. On top of all that, consumers are paying higher prices for imported goods.

For not good reasons 

We tend to think about economies in the aggregate. The reality is they are complex, made up of many firms, agencies and individuals, with an infinite network of connections. Parts of the economy can behave differently at any one time. For example, whole economy GDP has increased by 24% over the last decade but manufacturing output has been flat. Households face very different economic challenges, depending on their income and wealth. We think about factors that make life difficult for households – increased cost-of-living, the rise in gig-economy jobs, higher interest rates – and scratch our heads as to how the economy can keep motoring. The important point is not everyone’s income is the same – an obvious statement but the consequences are meaningful, especially in the US where income inequality has significant social, political and economic consequences.

Markets wag the economy 

According to official US data, the mean income of the top quintile of households rose by a cumulative 32% between 2003 and 2023 (the most recent data available). By contrast, the mean income of the lowest quintile household rose by just 12%, with the middle quintile (the famed US middle class) seeing a 17% increase. The rich have got richer, relatively, and the poorer have struggled to see any increase in real incomes over the last decade. Their spending is not the driver of economic growth, and what happens to the lowest income cohorts, does not cause recessions. Tariffs and tax cuts are likely to make trends in real income disparities worse.

The rich don’t need to solely rely on their salaries; they are more likely to own assets (equities, bonds and real estate) and to benefit from the income and price appreciation those assets generate. Official data shows that on average over the last 50-years, asset income has grown by 6.2% per year, versus wages and salaries growing at 5.7%. High income cohorts earn more, see more income growth, and benefit from income and capital gains from their financial and real estate portfolios. The only time when this income flow is disrupted is of course when there is a market correction. There is an obvious circularity – when markets correct, income and capital gains fall, spending is hit and a recession emerges. But when markets go up, income and capital gains turn positive, spending from higher income groups resumes and the economy grows.

This positive dynamic is at play today. Lower income households are unlikely to be benefitting from technology stocks growth, but the wealthier are, as they own them in their 401k retirement plans or brokerage accounts. For a recession to occur, something needs to break the stock market; and to break the stock market you need a shock – monetary tightening or a collapse in confidence. I don’t think the Fed is going to tighten again and shocks to confidence are hard to predict (and may not last very long, such as the period after 2 April). Think back to the pandemic. The rapid recovery following the initial lockdown shock was largely due to policy measures that allowed markets to recover quickly – benefitting higher income households – despite the consensus at the time that the US was in for a long and deep slump.

More or less equal 

The US is an extreme. The Gini coefficient is a measure of income inequality with a coefficient of zero indicating perfect equality and 1, absolute inequality. The World Bank provides an income inequality estimate based on the Gini methodology and a scale of 0-100. For 2023 the measure was estimated at 41.8 for the US. Countries with a higher measure (greater inequality) include places like South Africa (63.0), Brazil (51.6) and Turkey (44.5). Those with lower measures (more equality) included the UK (32.4), France (31.2) and Norway (26.9). With more income equality, a shock to real incomes (like the energy price shock in Europe in 2022) tends to have a broader and more aggregate impact. Germany’s decline in real GDP since 2022 is in part explained by this, although there are clearly other factors. The current US budget proposals, if anything, will merely entrench further income inequality, keeping the US economy highly leveraged to financial markets and the ability to sustain super profits in technology. In an unequal society, a rising tide does not necessarily lift all boats, but in a more equal one, a sudden deluge can sink them all. The policy model in Europe’s socially-democratic environment tends to address inequality and the challenge is to balance that with stimulating growth. In the US, the policy model tends to boost growth but paper over the inequality with populist promises.

Momentum is positive 

Most of the time we are not in recession and the positive feedback loop in the US supports strong equity returns and economic growth. The accumulation of that is a stock market with much higher valuations than anywhere else, aided by its own positive dynamics attracting money in from the rest of the world. Latest readings for a measure of equity index price momentum, based on one-month and three-month changes, puts US indices towards the top of an international comparison (22 different indices) with only Korea and Israel topping the US. This measure recently turned lower which may indicate some underperformance of global equities for a while – subject to sentiment of course, which appears forgiving to policy shenanigans.

But valuations are rich 

I’ve talked a lot about valuations and in our market strategy at AXA IM we always try to balance the impact of valuations, with macroeconomic factors, sentiment and technical influences on the market. Often, it is the case that valuations are high for certain asset classes because the macro (or broader fundamentals such as profits and leverage) is also positive. I looked at a range of valuation metrics for rates, credit and equities and calculated normalised scores for them relative to their distribution over the last 25 years – real rates, curves, credit spreads, price-earnings (PE) ratios and dividend yields. Not surprisingly, there are few assets flashing cheap. The cheapest ones are mostly UK – equities, long-end government bonds, real rates and overall credit yields. But when we think about the macro backdrop to the UK – Brexit, anaemic growth, persistent inflation and fiscal deterioration – it’s no wonder sterling assets are cheap. Away from the UK, European equities (dividend yields) and real rates score reasonably well.

Politically pricey 

No surprise either for what flags as very expensive – US equities and credit spreads in general. Exceptionalism is priced in, with earnings per share growth required to be even higher than current analyst consensus forecasts to justify the current price-earnings multiple (never mind allowing the PE to revert to its longer-term average). The current political push to lower taxes and regulation favours a return to capital rather than to labour, extenuating income inequality and raising the firepower of those higher income cohorts. It's uncomfortably hard to see how this all stops. Recessions have always led to lower profit margins and earnings, but the US seems to have become more resistant to recessions. Meanwhile, the rest of the world is dogged by sluggish growth, structural brakes on investment and innovation, and political systems that are weighed down by debt. The US is also becoming fiscally burdened, but the constraints are less because the rest of the world finances the US and in return the leveraged, socially unequal machine continues to generate growth. I don’t understand why Trumpism wants to throw sand in the machine.

Trump and market concerns (again) 

However, this week’s round of tariff threats and Trump’s consistent attacks on Fed Chairman Jerome Powell, could backfire on the US. Inflation break-evens are starting to move higher – the five-year/five-year inflation swap rate has continued to move higher, the dollar is weakening again, even Bitcoin is testing new highs. The minutes from the Fed’s June 17-18 meeting clearly articulate the broad concerns about inflation moving higher, even if the tariff impact is temporary. Investors should be concerned that after supporting a budget which will add trillions to the US’s outstanding debt, President Donald Trump is pressuring the Fed to cut rates to reduce the cost of financing that debt – something which economists call “fiscal dominance”. The risk is higher yields, a weaker dollar, higher inflation, and eventually, credit and equity valuation corrections. Long credit is a very strong consensus, and as a Bloomberg article suggested this week, more and more of that is being expressed in a leveraged way through the credit default swap index market. The risk of an extended move - e.g. around tariffs or the Fed - is rising. After strong risk momentum, it might be time for tactical investors to potentially take a more cautious approach again.

Performance data/data sources: LSEG Workspace DataStream, ICE Data Services, Bloomberg, AXA IM, as of 10 July 2025, unless otherwise stated). Past performance should not be seen as a guide to future returns.