Stocks and the Middle Class Problem

Agence France-Presse/Getty ImagesThey could do something if they wanted

It seems that after a nearly three years of (bumpy) gains, sentiment is shifting in the direction of stocks — maybe, just maybe, we’re finally seeing the Great Rotation back into�equities.

It’s true that many investors have missed out on rising stock prices, and it’s fair to argue that their return to the market, coupled with signs of a recovering economy, point to further gains to be had.

But there could be a big fly in that particular ointment, one that could hinder stocks more than we realize: amid all the empty talk of debt ceilings and deficits there’s one issue that’s being overlooked:

Wages have fallen to a record low as a share of America�s gross domestic product. Until 1975, wages nearly always accounted for more than 50 percent of the nation�s G.D.P., but last year wages fell to a record low of 43.5 percent. Since 2001, when the wage share was 49 percent, there has been a steep slide…

Meanwhile, it�s been a lost economic decade for many households. According to the Center for Budget and Policy Priorities, median income for working-age households (headed by someone under age 65) slid 12.4 percent from 2000 to 2011, to�$55,640. During that time the American economy grew more than 18 percent.

Those numbers are from a great piece by Steven Greenhouse over the weekend that considered an issue that our political class steadfastly ignores: the decline of middle class wealth.

It’s often noted that a big chunk of Standard & Poor’s 500 company revenues from overseas, and that’s true up to a point — the US still accounts for 54% of sales, however.�The health of the demographic chunk that does most of the buying in this country should be important to every investor — and by many lights the situation isn’t good at all.

It’s not just that middle class incomes have stagnated and even fallen (in real terms) in recent decades. In the bigger picture, little is being done to address unemployment, while the most recent policy battle, over taxes, actually ended up hitting the middle class pretty hard, with the expiration of the payroll tax taking 2% out of most people’s paychecks:

The 2 percentage point increase in taxes will take $125 billion from consumers� pockets this year, estimates�Michael Feroli, chief U.S. economist for JPMorgan Chase & Co., which in October lowered its forecast for first-quarter economic growth to 1 percent from 1.5 percent.

So where does that leave us? With retailers worried about consumer spending, companies continuing to make layoffs as a way to improve margins, wages still stagnating…and policymakers doing nothing to address what’s becoming a chronic problem.

Now, you could argue that we’re on the cusp of an innovation that will power new industrial jobs, or that as wages increase in emerging markets, we’re going to see many manufacturing jobs come back to the US. You may also hope that politicians fix the country’s fiscal problems and leave us with a fairer, more progressive system that will reenergize the middle class and help power the US economy.�But that way of thinking is medium-term at best, and somewhat too hopeful at worst; and in any case it doesn’t address the problems we’re facing in 2013.

In recent weeks, looking at the data I’ve made a fairly bullish case for the economy, and thus markets. But I think it’s also plausible to see that, bubbles aside, if nothing is doing to fix the problem the relative decline of the middle class will put a cap on where stocks can go in the months and years ahead.