Financial economy & real economy

What has the increasing wealth inequality in developed nations meant for financial markets & the real economy?
John Bilsel

Innova Asset Management

Yes, financial markets and the real economy are not the same, but that relationship is not constant over time. If participants in the real economy did not exhibit wealth inequality, these two could be quite independent which was what we were closer to pre-GFC. However, the past ~15 years it has been clear that the wealth inequality has grown via bailouts of private institutions and immense money printing, asymmetrically growing the wealth of the rich and hurting the lower-income earners:

Source: Innova Asset Management, Bloomberg

Source: Innova Asset Management, Bloomberg

If wealth inequality has become materially larger in the US, then we should expect a changing relationship between the real economy and markets. Why?

50% of consumption in the United States is driven by the top 10% of population (richest, most asset-wealthy individuals), up from ~30% in 1995.

Source: Moody's Analytics
Source: Moody's Analytics

A significant pullback in financial and asset markets, where the wealthiest primarily store and grow their wealth, can trigger a negative wealth effect and a confidence crunch. This would materially hurt consumption within the US economy. While not equating the real economy with the financial economy, this highlights a time-varying relationship where the real economy is increasingly sensitive to the spending patterns of the wealthiest.

2025 Example

Take Q1 2025 as an example where US household net worths sunk by -$1.6 trillion, the largest decrease since 2022. The large loss in the value of equity holdings (-$2.3 trillion) was the greater driver of this. That’s quite a significant blow to the wealth of these top decile earners, which may in turn lead to less spending, and hence lower GDP.

Source: Innova Asset Management, Bloomberg
Source: Innova Asset Management, Bloomberg

In the United States, approximately 70% of household wealth is tied up in the equity markets. As a result, equity market volatility may significantly affect consumption patterns.

A similar dynamic has played out in China, though centred around real estate: around 60–70% of household wealth was concentrated in property. Following widespread bankruptcies, consumer confidence collapsed, spending stalled, and savings rates rose. However, unlike the U.S., consumption comprises only 35–40% of China’s GDP.

What about Bond Markets?

As illustrated in the chart below, we know that markets now are inherently more sensitive to macroeconomic volatility and surprises, which is also a link between the real economy and the financial economy.

Source: Innova Asset Management, Bloomberg
Source: Innova Asset Management, Bloomberg

So, in this regime, the 2 most popular asset classes are clearly more sensitive to macroeconomics, or in another words, the real economy.

Well, wouldn’t a market selloff lead to less demand for goods and services and therefore lower inflation?

Unfortunately, given the tariffs that are in place, import costs will be higher (US manufacturers must pay tax to US government to buy exports from rest of world), and hence this can cause upward pressure on prices.

This creates a significant dilemma for the Federal Reserve. Ideally, the Fed would lower interest rates to stimulate a stagnating economy, but elevated prices limit their ability to do so without exacerbating inflation. Compounding this issue, the U.S. government must finance growing budget deficits and continue to raise the debt ceiling—a process increasingly scrutinized by markets, as evidenced by rising term premiums and signs of foreign divestment and waning trust. The Fed is caught in this stagflation-lite type environment and historically we’ve seen rampant government spending make the Fed not act as independently as it would’ve liked to.

Summary

In today’s financialised economy, the market is not the economy, but the market increasingly shapes the economy.

The post-GFC era has bred a fragile equilibrium—where asset markets prop up consumption and consumption props up GDP. As inequality grows, the line between Wall Street and Main Street becomes more of a feedback loop than a dividing wall.

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This document has been prepared by Innova Asset Management Pty Ltd (Innova), ABN 99 141 597 104, Corporate Authorised Representative (402207) of Innova Investment Management Pty Ltd, AFSL 509578 for provision to Australian financial services (AFS) licensees and their representatives, and for other persons who are wholesale clients under section 761G of the Corporations Act. To the extent that this document may contain financial product advice, it is general advice only as it does not take into account the objectives, financial situation or needs of any particular person. Further, any such general advice does not relate to any particular financial product and is not intended to influence any person in making a decision in relation to a particular financial product. No remuneration (including a commission) or other benefit is received by Innova or its associates in relation to any advice in this document apart from that which it would receive without giving such advice. No recommendation, opinion, offer, solicitation or advertisement to buy or sell any financial products or acquire any services of the type referred to or to adopt any particular investment strategy is made in this document to any person. All investment involves risks, including possible delays in repayments and loss of income and principal invested. Any discussion of risks contained in this document with respect to any type of product or service should not be considered to be a disclosure of all risks or a complete discussion of the risks involved. Past performance information provided in this document is not indicative of future results and the illustrations are not intended to project or predict future investment returns. The performance reporting in this document is a representation only. Innova has used a calculation methodology to simulate the performance of the relevant Investment Program since commencement, net of all fees and commissions at the fund/security level, and gross of other fees and commissions. Simulated performance does not reflect the performance of any specific account. Each account will have its own unique performance history, due to factors including varied methods of implementation, fee and tax structures. Therefore, simulated performance may vary significantly compared to that of any specific account. The out of sample backtested performance data has been simulated by Innova and is for illustrative purposed only, and is not representative of any investment or product, Results based on simulated performance results have certain inherent limitations as these results do not represent actual trading. No representation is being made that any account will or is likely to achieve profits or losses similar to those being shown. Although non-Fund specific information has been prepared from sources believed to be reliable, we offer no guarantees as to its accuracy or completeness. Any performance figures are not promises of future performance and are not guaranteed. Opinions expressed are valid at the date this document was published and may change. All dollars are Australian dollars unless otherwise specified.

John Bilsel
Quantitative Investment Analyst
Innova Asset Management

John is an Investment Analyst at Innova Asset Management, specialising in multi-asset investment research, risk management, portfolio construction, and quantitative research. He also oversees Innova's ESG portfolio capabilities. John holds a...

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