Politics, the welfare state and capital markets

The next federal elections will take place in two months' time. We do not want to speculate here about the possible colors of the next government (black-red-yellow, red-dark-red-green, black-green-yellow, green-red-yellow,...). However, there are some false narratives that have already led to political redistribution measures in the last 10 years at least. However, these have been detrimental to income growth and prosperity, not least for the "little people", as will be shown below. If politicians continue to be unwilling or unable to make sensible analyses the basis of a future-oriented policy, the wealth creation that is urgently needed in Germany will continue to be politically torpedoed. The rent cap and rent brake will reduce the profitability of real estate ownership, thus also reducing the willingness to invest and later the supply, so that real estate prices will continue to rise and the opportunities to acquire real estate ownership will continue to fall. The introduction of a wealth tax, possibly garnished by the abolition of the flat-rate withholding tax, will drive up the effective taxation of corporate profits to over 70% (see Capital Market Outlook from May 2021, which you can find here ). This would make investing in the other important tangible asset, shares, less attractive. In Germany in particular, with the low participation of the less affluent in inflation-proof tangible assets, such a development would be fatal, especially as its political justification is based on completely false assumptions.

Let's start with the "injustices". People like to point to the "higher earners" who should pay more tax, as an unequal distribution of income or wealth is perceived as somehow unfair. The distribution of income or wealth is assessed using the "Gini coefficient", whereby a value of 1 means that a person owns or earns everything (extreme inequality). A Gini coefficient of 0 means that everyone has the same amount wealth or income. This means that, at first glance, income in Germany is actually quite unequally distributed and therefore the "injustice" is high (see chart below left, according to which even countries such as the USA or Russia have less unequally distributed incomes). However, this problem has already been solved in Germany, as the chart on the right shows. If the same countries are ranked taking into account the redistribution of social benefits, only in France is income distribution less unequal and therefore "fairer" than in Germany. Consequently, increased income taxation cannot be justified on the basis of alleged injustice.

However, it would further increase the incentive for well-educated "high earners" to emigrate, which would deprive the state of urgently needed highly qualified workers, but of course also of tax revenues and social security contributions.

Increased redistribution would have further negative consequences in the long term. In Germany, we are rightly proud of our strong economy and - not entirely rightly - of our strong welfare state. Far too little attention is paid to the fact that it is precisely this that ensures that a shockingly large proportion of the population does not benefit from this strength in an international comparison, as will be shown below.

The next chart at the bottom left shows that the upper class, in this case the richest 10% of Germans, has definitely benefited from the strength of the domestic economy. With the exception of a few small countries that have attracted a lot of wealth , particularly as tax havens (Luxembourg, Cyprus, Ireland, Malta), only Belgium, with the EU capital Brussels, has a particularly high per capitawealth of the richest 10% of the population. Otherwise, Germany is just behind Austria and closely followed by Spain, France, Italy, Finland and the Netherlands at the top of the wealth pyramid in Europe.

Even the net wealth of the middle class (top right) looks significantly more modest; here Germany is already well below the eurozone average and cannot compete at all with the alleged hunger sufferers, e.g. Italy. Particularly shameful in Germany, however, is the per capitawealth of the lower middle class (see below left) and the remaining 20% (below right), who own practically nothing and are therefore considerably poorer than Italians or Portuguese in the same wealth class. Surprisingly, even the poorest 40% of the inhabitants of the former Eastern Bloc countries (with the exception of Latvians), who had virtually no opportunity to build up wealth until 1990, are wealthier than the corresponding class of Germans. So, contrary to the omnipresent narrative, the injustice is not that the "rich" have a huge wealth - after all, some of them have created companies (example: SAP) that today offer tens of thousands of well-paid jobs - but that 40% of the German population have practically no wealth and are therefore at the bottom of the international league table despite (or because of?) a lavish welfare state. This situation needs to be explained in more detail, as it is ultimately due to the same political mistake that has obviously not been made in other countries, or not to the same extent. It also tempts irresponsible and often ignorant politicians to reduce inequality at the wrong end, i.e. to make the "rich" poor instead of the poor rich.

Just as is now becoming apparent in the fight against climate change (possibly the subject of the next Capital Market Outlook), politicians in Germany are also consistently avoiding putting a price tag on the redistribution measures of the past (mothers' pensions, skilled workers' pensions, ...) and those planned for the future (unconditional basic income?, ...) in social policy. The redistribution outlined above comes at a very high price, which low earners have to pay in the form of high social security contributions. As a result, their marginaltax and social security contributions reaches over 55% and for middle-income earners even an incredible 60%. With the exception of Sweden, even top earners in countries such as Switzerland, the UK, the USA and Spain, as well as in Germany, pay significantly less on additional income than German low earners (source: Manager Magazin, August 2020, p. 104). This explains the physical impossibility for the lower and middle income groups to build up wealth

Here we can see the sad correlation. The lavish German welfare state only helps to equalize incomes, as the two charts on the first page have shown. In eliminating the very unequal distribution of wealth in Germany, the welfare state has achieved the opposite of what one would expect.

In summary, the data shows that a new German government must finally tackle the problem of non-existent wealth accumulation in large sections of the German population, as they are very poor by international standards, but the "rich" are not particularly rich. The only part of many Germans' wealth that is not included here (see next paragraph for reasons), their pension entitlement, will lose much of its value in the coming decades due to weak demographics, a declining willingness to work, high tax burdens and the growing emigration of "higher earners".

Why is pension entitlement a very shaky asset? Another narrative that tends to be popular in conservative circles points to Germany's low level of debt compared to the unsound southern Europeans, which is a frequent reference to Italy. The chart on the left below seems to confirm this. However, the chart on the right shows the sad truth. At around 75% of national income, corporate debt is equally high in both countries. However, both private households and the state are significantly more indebted in Germany than in Italy if the implicit public debt is included, which is even slightly negative in Italy (can be seen under the dark blue area of Italy in the right-hand chart), but significantly higher in Germany than the officially reported public debt. So are the Italians not only better at soccer?

The implicit national debt arises when pension commitments are made that are not fully covered by the future pension insurance contributions of employees, but must be offset by future subsidies from the state (the German government is already paying over €100 billion a year into the pension fund, as even Ms. Merkel's predecessors were no friends of honest accounting). This means that the state's debt is already calculable today, but does not have to be shown because the politicians have regulated this by law. Entrepreneurs are of course obliged to show the equivalent value of such future payments in the balance sheet as a liability item (pension provision), but politicians would prefer to conceal this inconvenience and leave it to their successors. Unfortunately, for most of the poorer Germans, the already partially unfunded pension commitments are the only significant asset on which they rely. If we now look again at our southern neighbors, we can see from their negative implicit national debt that this trust in permanently undiminished pensions is unfounded. In the course of rescuing Italy during the 2011 euro crisis, the ECB demanded a massive reduction in the Italian state's pension commitments in return for aid money. The government there agreed to this and drastically reduced the entitlements of younger Italians, which also meant that Italy's implicit national debt disappeared. It was rightly assumed that the young Italians affected would not protest, because for them the problem of a lack of pension provision was in the distant future. Of course, one of the next German governments will also start to cut pension commitments, e.g. by raising the retirement age (the most harmless way in economic terms and the right one in terms of content). However, there are already fierce protests against this; Chancellor candidate Scholz is playing down this problem against his better judgment. The conclusion is that sensible, i.e. extremely cost-effective and equity-based pension provision is absolutely essential in Germany in order to supplement the growing pension gap. Otherwise, the German state will be faced with massive additional expenditure that can hardly be managed without permanent help from the ECB.

Establishing a low-cost equity-based pension scheme (see Capital Market Report from March 2021, Chapter C., which you can find here ), as other countries have done, would be an effective long-term measure to combat the high level of wealth inequality in Germany. Another would be to improve access to property ownership for middle and lower income earners too, e.g. by simplifying building regulations for housing construction (number in 1990: 5,000, 2021: 20,000), providing affordable building land or waiving land transfer tax for first-time buyers on low incomes. None of this can be found in the party manifestos; on the other hand, the demand for expropriation of housing companies, which brings absolutely no new housing, seems to be popular. In many other countries, people in the bottom fifth of the wealth pyramid also own real estate, e.g. 51% of this group in Italy and even 63% in Greece (source: beyond the obvious (Dr. Daniel Stelter) from 17.7.2021). In a number of former Eastern bloc countries, state-owned apartments were given to tenants after 1989. In oh-so-social Berlin, on the other hand, affordable apartments were sold off en masse to housing companies at rock-bottom prices over 15 years ago, so that today only 15% of Berliners own their own home. With inflation rates set to rise in the future, the population in Germany will therefore be exposed to far higher poverty risks than in almost all other European countries, without politicians showing any interest in this, let alone working on solutions.

The spread of nonsensical and harmful narratives has reached an impressive level under Donald Trump, unimaginable in a world of mass availability of free information, e.g. Trump's corona denial. The graph above shows the correlation between the proportion of vaccinated adults and Trump voters in the individual US states. Thanks to this "president", corona will still cause a lot of unnecessary damage in the USA, at least among his supporters, just as the bloated welfare state has long done more harm than good to the poorer part of Germany's population.

Politicians' economically incorrect responses to questionable narratives, in particular the excessive expansion of the welfare state, have contributed significantly to the current debt situation in industrialized countries. We do not believe that things will improve in the future, not least because the economic side of the problem is likely to be deliberately ignored in the fight against undeniable climate change, and not just in Germany. As a result, government debt will continue to rise faster than national income everywhere and central banks will be less and less able to combat inflation by raising interest rates. The capital markets have now finally recognized this. As a result, long-term interest rates have shown virtually no reaction during the current rise in inflation, and not only in the USA (see chart below).

Rising government debt therefore means that investors enjoy permanently low interest rates (see below) and the equity markets therefore remain fundamentally promising.

However, it will be increasingly necessary to differentiate; the global equity market index (MSCI ACWI) is no longer particularly attractive with earnings expectations in the low single-digit range (see chart below right, red oval) and will not be able to achieve the high single-digit returns of the last 26 years in the next 10 years (chart below left). By contrast, some sectors with historically less volatile earnings figures (dividends, cash flows) such as healthcare stocks or consumer staples with expected returns of around 7% (right chart, green ovals) will be able to almost match their historical performance.

The following charts show why the global equity market should focus more on a few sectors with long-term prospects and no longer just on the average.

At the bottom left you can see that the future 10-year performance is closely linked to the current price/cash flow ratio (KCFV). An apartment building that you can buy for 6 times the annual rent (for comparison: the KCFV of the global stock market in 2009, blue curve in the green circle) will generate a double-digit performance (red curve also in 2009 in the green circle). However, if this ratio is very high, future returns are also very unfavorable (red circle in 2000), which is also confirmed by the chart on the bottom right.

The dividend yield of the average global share is also unattractive, as is the earnings expectation (bottom left). The reason for the overvaluation is probably the enormous buying frenzy of investors in the first half of 2021 (bottom right).

In contrast, the healthcare sector and also the consumer staples sector worldwide show quite normal valuations and thus also earnings expectations (over 7% p.a.), which are significantly more attractive with very high forecast quality (see charts below).

A more differentiated approach should therefore be taken to equity investments. Overall, however, equities remain rather attractive in view of a foreseeable long phase of extremely low interest rates; we will take advantage of temporary double-digit slumps to make additional purchases.

Finally, a small note on crypto "currencies" (sorry, Elon). Ironically, the first zero interest rate-induced hyperinflation is currently taking place in this supposedly inflation-protecting asset class, with cryptocurrency being printed en masse (see chart below). Furthermore, one should avoid an "asset class" that is dependent on the tweets of an electric car CEO who is only partially reputable and has already been sentenced to high fines in the double-digit million range by the US Securities and Exchange Commission (SEC) for manipulating the share price of the company he heads. He is therefore now shifting his focus to the completely unregulated crypto sector. Elon, we're probably not going to be friends anymore, but of course you couldn't care less.