Are you ready for Bill Gross’s latest missive? He’s waxing quite pessimistic this month.
Gross avers that, “Greed will come again.” The problem is that he might well be in his crypt by the time it arrives since he thinks it will take a generation.
PIMCO and yours truly are not masters of the antithesis, a subjective approach which might derisively be called “crystal ball gazing,” but we try to focus on what might be legitimate changes in the way economies and financial markets are affected by seemingly irrational or “non-normal” behavior and events. The supersizing of financial leverage and consumer spending in concert with the politicizing of deregulation describes in fifteen words our most recent brush with irrational behavior and inefficient markets. Greed will come again. But for now, the trend is the other way and it promises to persist for a generation at a minimum. The fact is that American consumers have suffered a collapse in wealth of at least $15 trillion since early 2007. Global estimates are less reliable, but certainly in multiples of that figure. And when potential spenders feel less rich by that much, the only model one can use to forecast the future is a commonsensical one that predicts higher savings, lower consumption, and an economic growth rate that staggers forward at a new normal closer to 2 as opposed to 3½%. There’s no magic in that number, and no model to back it up, just a lot of commonsense that says this is how people and economic societies behave when stressed and stretched to a near breaking point.
Gross is basing his forecast on an analysis that relies not just on econometric models but on expected human behavior. He seems to think that the shocks of the past two years are going to reshape human reaction and interaction to future events. Essentially, he seems to see a more risk averse and conservative consumer.
He then overlays this with structural changes that he sees occurring in the economy to reach the conclusion that slow growth and historically depressed returns to financial assets will be the norm:
What this all means to you as an investor is near obvious as well. Unsurprisingly, what still can be modeled is the direct correlation of real profit growth to real economic growth, assuming a constant division of the “pie” between profits, labor and government. If long-term economic growth declines by 1½% then profit growth will as well. This, after settling at perhaps half of absolute peak profit levels of 2007, because of the rise of savings rates from 0 to 8% or higher. But to add to the woes of the investor class, one has only to observe that their share of the pie is shrinking. What does the General Motors example tell us all about the rebalancing of power between the investor class and the proletariat? What do trillion-dollar deficits and the recent reinitiation of PAYGO government programs tell you about the future of corporate tax rates? They’re headed higher. Do you really think that a national health care program can be paid for with cost-cutting as opposed to tax hikes at insurance companies and benefit-paying corporations throughout all sectors of the American economy? The new normal will not be investor-friendly unless your forecasting dial is turned to “Pollyanna” or your intelligence quotient is significantly less than 100.
This isn’t new stuff which you will recognize if you’ve been following Gross. I don’t know how much he’s just talking his book — he always does — but there is truth in what he has to say as well. I’m not so sure that human nature will take us to the conservative future that he predicts. I tend to think that we are by nature risk takers and optimists, sometimes foolishly so, and that may well cause us to shrug off some of the baggage accumulated recently. I put more credence in his analysis of the structural changes, mostly political, that are taking place. Those alone may be enough to create his slow growth future.
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