Not too long ago, it was conventional wisdom: Personal wealth comes not from wages, but from return on investments. Stocks are for the long run. Houses always go up in value. That works so long as the economy works.
But then the financial roof fell in, and the Fed came along and decided to abolish interest, or at least attempted to. Inflation steals whatever morsels fall from the table. Then economic growth and income have slowed to a crawl. Stagnation has set in.
Now we are stuck… unless you run a high-frequency trading machine that lives on razor-thin margins.
But what about equities, the saving grace of the past generation? Bad news here, too. Pimco’s Bill Gross announced news this week of which that you might have been already been painfully aware.
“The cult of equity is dying,” writes the bond king. In his long missive to the Pimco world, Gross goes on to wax philosophical using the image of aspens changing colors in a Colorado autumn. He wonders:
Several generations were weaned and, in fact, grew wealthier believing that pieces of paper representing “shares” of future profits were something more than a conditional IOU that came with risk. Hadn’t history confirmed it? Jeremy Siegel’s rather ill-timed book affirming the equity cult, published in the late 1990s, allowed for brief cyclical bear markets, but showered scorn on any heretic willing to question the inevitability of a decade-long period of upside stock market performance compared to the alternatives.
Yes, looking back over the past three decades, it turns out the safety of holding government debt not only provided a port in the financial storm, but returns exceeding those of stocks.
Sheesh, but we’ve all been told that for the long run, we must hold stocks. Buy and hold. More risk means more reward. The younger you are, the more equities you should hold. Every 401(k) administrator and financial planner has charts and graphs painting the glorious picture of everyone becoming a millionaire if they would just put money in equities in their early working years and for god’s sake leave it alone!
After all, Jeremy Siegel, the author of Stocks for the Long Run, points out that $1 invested in stocks in 1912 is now worth $500. “No wonder today’s boomers became Siegel disciples,” writes Gross. “Letting money do the hard work instead of working hard for the money was a historical inevitability, it seemed.”
Gross go on to point out that Siegel’s 6.6% real return isn’t really possible going forward, and if it were, the holders of stocks would hold 16 times more in wealth than folks who put their savings in NASCAR decanters or baseball cards. A gulf of that size between rich and poor would surely lead to civil unrest.
Higher stock returns is the way it is supposed to work out because stockholders are further down the capital stack from bondholders (in a bankruptcy, equity holders are wiped out and creditors have a chance of recouping some of their investment) So stocks must return more than bonds to compensate for the risk being taken.
“Companies typically borrow money at less than their return on equity and therefore compound their return at the expense of lenders,” Gross explains. “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.”
Gross presents a chart showing that real wages and salaries as a percentage of GDP has fallen steadily (excepting a jump from ‘95 to ‘00) from over 53% in 1970 to 44% today. In other words, capital has done better than labor, due to technology and outsourcing.
Gross also writes that corporate taxes as a percentage of GDP are at 30-year lows. Thus, he’s thinking that, going forward, government and labor will be reaching for a bit more of the pie at the expense of equity holders. Add to that the heavy government and private debt yoke around the economy’s neck and the prospects for equities going forward isn’t all that hot.
So you might be thinking, Oh, so the Bond King is talking his own (bond) book.
Well, not exactly. Gross doesn’t think bonds can perform as well as they have for the past 30 years. A long Treasury yield of 14.5% back in 1981 by itself has made bond index performance stellar for the past three decades.
But as Gross points out, “What you see is what you get more often than not in the bond market, so momentum-following investors are bound to be disappointed if they look to the bond market’s past 30-year history for future salvation, instead of mere survival at the current level of interest rates.”
This is all bad news for public pension plans that continue to assume they will earn 8% on their portfolios and base payouts to retirees upon this accounting chimera. But the clear message to baby boomers is that the financial assets that your broker or Money magazine recommends to you are not going to work for you above the rate of wealth creation.
Instead, you will have to work longer; possibly suffer losses on your existing holdings and pensions; or, as Gross emphasizes, “both.”
What Gross accurately puts his finger on is that governments are doing all they can to reflate away liabilities, but “inflation doesn’t create real wealth and it doesn’t fairly distribute its pain and benefits to labor/government/or corporate interests.” He even guesses that the negative nominal (let alone “real”) interest rates seen in some parts of Euroland will become commonplace.
So while the cult of equity is dying, and the bond market’s best days are behind it, “the cult of inflation may only have just begun.”
High inflation, negative interest rates, sinking stock values — what’s an investor to do? There’s no time to waste. Addison Wiggin has thought through this doomsday scenario. He’s the author of The Demise of the Dollar and The Little Book of the Shrinking Dollar. He has practical advice for you to act on today in order to survive the coming years. Find out how Addison can protect your golden years.
