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Weekend reading: The death of equities, or a simple mathematical error?

Weekend reading

Good reads from around the Web.

This week saw the well-respected bond titan Bill Gross predict the death of equities:

The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of “stocks for the long run” or any run have mellowed as well.

The key thrust of Gross’ argument is that:

[Equities’] 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.

Unfortunately, Gross appears to have made a (wait for it) gross error. As the likes of Jeremy Siegel and Henry Blodget have pointed out, he has forgotten that a large part of that 6.6% real return consists of dividend payouts:

Stocks have not, in fact, “appreciated” at ~7% per year for the past couple hundred years. Stocks have only “appreciated” about 2% per year.

That is to say, the prices of stocks, after adjusting for inflation, have only risen about 2% per year for the past couple of centuries.

So where has the rest of the return come from?


Over the past century, about 4 points of the ~7% annual return of stocks has come from dividends.

This would seem to be an inordinately huge error, but Gross has yet to address it. Instead he and Siegel have traded insults across the financial media:

“I like Bill Gross a lot, but he’s got the economics wrong,” Siegel said on Bloomberg Television’s “In the Loop” with Betty Liu. Siegel is “obviously pushing at windmills,” Gross said today in an interview with Liu. “He belongs back in his ivory tower,” Gross said.


A load of crystal balls

Other critics have noted that plenty of US companies get much of their earnings from overseas. Thus their business value would be geared to global GDP, not to US GDP alone.

But the main thing I takeaway from this spat is that fun as it is to read the word of gurus and pundits, an investor shouldn’t regard any of it too seriously. (That includes any forecasts that stray onto Monevator, for that matter).

If a multi-millionaire bond king with billions under management like Bill Gross can make such a simple slip, do you really think an economist has a clue when he says Russian GDP will pick up in 2014, or that the FTSE will fall below 4,000 before rebounding to 10,000, or any other comically precise forecasts?

In the real world, central banks can’t get next quarter’s inflation figures right, and analysts who devote their working lives to tracking one company can be raving bulls just before profits crater.

Gross may or may not be right about equities (he’s been plenty wrong before) although his critics should note that he also thinks bonds face a tough future – so he’s not just talking about his book here.

I suspect too, that those who see his bearishness as a buy signal akin to the famous ‘Death of Equities’ Newsweek cover of 1979 may well be vindicated, though it’s worth noting that cover wasn’t as terribly timed as is popularly thought.

But even had his maths not been fundamentally wrong, the idea of reliable market forecasting is still wrong-headed.

From the investing blogs

Book of the week: A whole book dedicated to the price-to-earnings ratio might suggest writer’s block. But The Essential P/E, a new work by a British author, is right to challenge our reliance on this slippery ratio.

Mainstream media money

  • Triodos targets 9-10% return with new wind turbine fund – Guardian
  • How a trading bot cost its owner $440 million this week – Channel 4
  • Such large scale algorithms break in strange ways – Reuters
  • Its shares have tanked, but how is Facebook itself faring? – Economist
  • Facebook reminds us why most should be in trackers – DealBook/NYT
  • Unpacking the also-dubious Manchester United IPO – DealBreaker
  • Swedroe: When do the risks of value stocks appear? – CBS/Moneywatch
  • Nearly 50% of Japanese firms have more cash than debt – Bloomberg
  • Threat to cheap ETFs if stock lending rules are changed – FT
  • Alternatives: The price of antique atlases is soaring – FT
  • The case for private equity investment trusts – Telegraph
  • How to claim compensation from the RBS/Natwest glitch – Telegraph
  • The ins and outs of flexible working – Independent

Product of the week: Not a link to a specific product this time, but the first details on Tesco’s eagerly awaited mortgage range. And the news is that Tesco isn’t particularly cheap, as the FT points out.

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{ 10 comments… add one }
  • 1 ermine August 4, 2012, 1:18 pm

    Granted that Gross screwed up, but don’tcha think there’s some sense in the fundamental thrust of his argument? The Archdruid made the same point in his recent article, you may not agree with his world-view, but the pithy summary contains a grain of truth

    The investmentariat has been told for decades that their money ought to make them money, but nobody told them that this only works in an economy that experiences sustained real growth over the long term, and nobody would dream of mentioning in their hearing that we don’t have an economy like that any more.

    Your stock market return, and mine, has got to come from somewhere. That somewhere may be

    1 at the expense of somebody else (the 99% view)
    2 from some artifice within the system – the Bernie Madoff/CDS swap view
    3 the use of our capital to create new goods and services that people want

    or of course some mix of all three. I find it hard to argue with Gross (and the Archdruid’s) assertion that the overall value of goods and services in the economy has to be increasing in real terms for 3 to be possible, otherwise known as GDP growth. Otherwise capitalism will eat itself.

    As far as the composition of the total return, well it probably doesn’t really matter how much of consists of SP appreciation and how much as divis. However, the issue of assuming you can make money with money does give me some concern, as it looks rather like the developed world has gone ex-growth. I’m hoping it is that it looks darkest before the dawn, but I’m not totally sure at all!

  • 2 The Investor August 4, 2012, 1:34 pm

    @ermine — Sure, if GDP never grew again and the world had stopped innovating then stocks would be lousy investments. But as you know, on a multi-year view I don’t believe that is even faintly likely. Absent environmental collapse (a big if), the world stands on the cusp of decades of above average growth in my view. Even the peak oil fears seem to have abated now.

  • 3 Neverland August 4, 2012, 1:36 pm


    Even in Japan the post grandpa of stagnation there is growth amid the decline

    Growth: services and goods for the aged; Uniqlo; nuclear clean-up services
    Decline: job security; conspicuous consumption; diapers; Burberry macs

    There is a kernel of truth in what Gross is saying that is underpinned by statistics, in the US (and the West) companies have been taking an ever increasing share of wealth in the last 30 years as profits

    That trend of taking a rising share of profits can’t continue for ever

    PS. I think Gross will ultimately be proved right about UK gilts also

  • 4 Cogitator99 August 5, 2012, 1:57 am

    “Absent environmental collapse (a big if), the world stands on the cusp of decades of above average growth in my view.”

    Can you elaborate on that? It seems like the level of debt in the developed world (as Bass notes, “the greatest peacetime accumulation of debt in history”) should put a cap on growth from here.

  • 5 Paul S August 5, 2012, 7:23 am

    The Investor is quite right. Growth is being confused with profit. A mom and pop corner store can survive for generations with no growth at all but still turn a healthy profit. What investors are getting in their dividends is a share of the profits from a well-run business. If the economy grows too that is an opportunity for the business to grow; but it is not a prerequisite for getting a good return.

    You’re wrong about peak oil though.

  • 6 Drew @ ObjectiveWealth August 5, 2012, 7:17 pm

    You’re only as good as your last prediction, provided it turns out to be correct. The economic pundit who manages to guess correctly the longest is revered, but only until his luck runs out, which it will if he’s taking wild shots. Somebody like Peter Schiff stands out to me as one of the vocal few who is able to accurately predict (larger) trends and events, due largely I believe to his Austrian School position on economics.

  • 7 The Investor August 5, 2012, 8:40 pm

    Here’s one of a few attempts around the place at trying to monitor the pundit’s predictions:


    I’m not sure getting a prediction wrong is terrible news for a pundit, to be honest. It seems to me that as long as you can sound convincingly definitive (Roubini on the bearish side, Siegel on the bullish side, say) and be right every five years or so, you can keep your hand in.

    It’s the middle ground of reasonable pundits who get squeezed out, perhaps. (Lucky I made a (only half serious) outrageous prediction about the market in 2020, eh?)

  • 8 Paul S August 5, 2012, 10:18 pm

    I think it is unfair to call Jeremy Siegel a bull. He, like Robert Shiller, is an academic and he calls it as he sees it from the data. He may be wrong but I don’t think he has a hidden agenda.

  • 9 The Investor August 6, 2012, 9:44 am

    @Paul S – I guess it’s what one means by saying a bull or bear. My take on a bull is that his/her reading of the data is ‘bullish’; if the data changes they change their mind. I do get the impression Roubini say would be bearish in most conceivable scenarios, but I’m sure if we’d delevered, the world was delivering 4% GDP growth, and the FTSE 100 was at 3,000, even he’d say buy! 😉

    I’m not sure what animal I’d call someone who was bullish/bearish irrespective of the data (a muppet? 😉 ) But I do think they have tendencies. Siegel currently reads the data optimistically, and he has a historical tendency to do that — see his “Stocks for the Long Run”. Indeed, the Bill Gross piece I cited starts with a sly dig at exactly that title from Siegel.

    Anyway, I agree with you — I don’t see a hidden agenda.

  • 10 The Investor August 7, 2012, 10:59 am

    Can you elaborate on that? It seems like the level of debt in the developed world (as Bass notes, “the greatest peacetime accumulation of debt in history”) should put a cap on growth from here.

    @Cogitator99 — I just don’t believe the doom and gloom. The US consumer has already arguably delevered to normal levels (not to historically under-geared levels) and I think Europe will eventually pootle along with mediocre growth once the current crisis abates. Meanwhile, the rest of the world is becoming like we are. This is an outlying optimistic view, but it’s not pie-in-the-sky; there was some Goldman research the other day suggesting the next 2-3 decades will be the highest GDP growth the world has ever seen.

    I’d beware recency bias, personally. Several decades are a long time. But you pays your money and takes your choice. And, as I say, the environmental implications of this growth could be disastrous (indeed, one reason why I’m perhaps more gloomy than many about the environment is specifically because I see every Indian aiming to have a car and a fridge by 2050, as a random and unscientific example).

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