Submitted by Mark Hanna
Courtesy of MarketMontage. View original post here.
Mr. Gross does a 180 this month in his letter, and focuses mostly on stocks rather than the usual economic / bond talk. He makes an interesting claim on the future returns of the stock market, arguing that returns have been goosed by the massive long term shift of rewards towards capital rather than labor, and eventually that is going to hit the wall. As long time readers know the U.S. especially has seen a pronounced shift over the past few decades as labor gets less and less of corporate profits, and capital is rewarded.
If the tide turns in any meaningful way one could argue that might be better for society (or at least the labor part of society) but a drag on corporate profits. I don’t know if I buy any huge mean reversion as the genie is out of the bottle and the race for a constantly lower wage base continues the world over. Maybe Gross will be correct in 50 years, but most of us won’t be around to judge. Either way, it’s a thought provoking piece.
Full letter here. Some snippets below:
Yet the 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes – a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)? The commonsensical “illogic” of such an arrangement when carried forward another century to 2112 seems obvious as well. If stocks continue to appreciate at a 3% higher rate than the economy itself, then stockholders will command not only a disproportionate share of wealth but nearly all of the money in the world!
Cult followers, despite this logic, still have the argument of history on their side and it deserves an explanation. Has the past 100-year experience shown in Chart 1 really been comparable to a chain letter which eventually exhausts its momentum due to a lack of willing players? In part, but not entirely. Common sense would argue that appropriately priced stocks should return more than bonds. Their dividends are variable, their cash flows less certain and therefore an equity risk premium should exist which compensates stockholders for their junior position in the capital structure. Companies typically borrow money at less than their return on equity and therefore compound their return at the expense of lenders. If GDP and wealth grew at 3.5% per year then it seems only reasonable that the bondholder should have gotten a little bit less and the stockholder something more than that. Long-term historical returns for Treasury bill and government/corporate bondholders validate that logic, and it seems sensible to assume that same relationship for the next 100 years.
Disclosure Notice
Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog
