The Macro Trend of Asset Prices in the Age of Common Prosperity

How does a widening or narrowing income gap across society affect asset pricing and asset allocation? The focus on the wealth gap in recent years has led to an increasing number of academic studies introducing “heterogeneous individuals” (individuals who differ in certain respects, such as income or wealth levels) to the traditional “homogeneous individuals” analytical framework (in which only identical representative individuals are considered) to explore the impact of changes in income distribution on asset pricing. Most analyses agree that widening of income distribution and the wealth gap tends to make the risk-free rate fall and the risk premium rise. Also, under the assumption of institutional endogeneity, a widening wealth gap leads to a reduction in systemic stability, which also pushes up the level of the risk premium. The analysis of the historical experience of income distribution and asset prices in the US and Japan also provides insights into investment in the context of China’s move towards inclusive growth. The long-cycle history of changes in income distribution in the US shows that corporate profitability (e.g., return on net assets) does not appear to be affected by income distribution policies. Compared to past periods with relatively large income disparities, the average stock market valuation and volatility are relatively low, and sector valuation divergence is relatively small, during periods of relatively small income disparities. China’s current internal and external environment is somewhat similar to Japan’s in the 1970s. Japan’s historical experience of successfully upgrading its industries through technological innovation led to relatively balanced income growth and thus consumption upgrading. This also provides more insights into China’s current policy initiatives and investment trends, which could help the country achieve the goal of common prosperity. The drive toward more inclusive growth by China as well as the rest of the world could have far-reaching implications for global asset prices and asset allocation. From an investment perspective, there are a number of points to consider: (1) The “new paradigm” of investment: Around the world, the increased focus on equity over efficiency has objectively led to a more “inward-looking” policy orientation and a greater focus on versions of “ESG” that are unique to each country. Although regional frictions have increased, a number of countries have also used antitrust laws to target tech firms in their own markets, while also pursuing financial inclusion and concessions in other sectors. All of them have direct investment implications. (2) The global low interest rate environment is likely to change gradually. (3) A more balanced income distribution is expected to mitigate barriers to China’s development and further unleash China’s growth potential. (4) China’s mass consumption market could expand further and improve against the backdrop of more balanced income growth. (5) China’s domestic demand potential could be further unleashed. The country’s sizable domestic demand could help bring about the most substantial benefit as a result of economies of scale since the Industrial Revolution, and the trend in China towards industrial upgrading could be further strengthened. In addition, the trend towards inclusive growth, which may impose medium- to long-term constraints on finance, real estate, and related sectors, is also a cause for concern.