PIMCO Nov 2013 Investment Outlook.pdf

8/14/2019 PIMCO Nov 2013 Investment Outlook.pdf

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Your Global Investment Authority

Investment Outlook November 2013

Bill Gross

Scrooge McDucksWith the budget and debt ceilingcrises temporarily averted, perhapsa future economic priority will be topromote economic growth; one wayto do that may be via tax reform.

How to proceed depends as alwayson the view of the observer and whether the glasses areworn by capital, labor or government interests.

Having beneted enormously via the leveraging of capital since the beginningof my career and having shared a decreasing percentage of my income thanksto Presidents Reagan and Bush 43 via lower government taxes, I now nd myintellectual leanings shifting to the plight of labor. I often tell my wife Sue itsprobably a Kennedy-esque type of phenomenon. Having gotten rich at theexpense of labor, the guilt sets in and I begin to feel sorry for the less well-off,writing very public Investment Outlooks that dis the success that providedme the soapbox in the rst place. If your immediate reaction is to nod upand down, then give yourself some points in this intellectual tte--tte. Still,I would ask the Scrooge McDucks of the world who so vehemently criticizewhat they consider to be counterproductive, even crippling taxation of thewealthy in the midst of historically high corporate prots and personal income,to consider this: Instead of approaching the tax reform argument from thestandpoint of what an enormous percentage of the overall income taxesthe top 1% pay, consider how much of the national income youve beenprivileged to make. In the United States, the share of total pre-tax incomeaccruing to the top 1% has more than doubled from 10% in the 1970s to20% today. Admit that you, and I and others in the magnicent 1% grewup in a gilded age of credit, where those who borrowed money or chargedfees on expanding nancial assets had a much better chance of making it tothe big tent than those who used their hands for a living. Yes I know manyof you money people worked hard as did I, and you survived and prosperedwhere others did not. A fair economic system should always allow for anopportunity to succeed. Congratulations. Smoke that cigar, enjoy thatChateau Late 1989. But (mostly you guys) acknowledge your good fortune


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2 NOVEMBER 2013| INVESTMENT OUTLOOK

at having been born in the 40s, 50s or 60s, entering themale-dominated workforce 25 years later, and having hadthe privilege of riding a credit wave and a credit boom for thepast three decades. You did not, as President Obama averred,build that, you did not create that wave. You rode it.And now its time to kick out and share some of your goodfortune by paying higher taxes or reforming them to favoreconomic growth and labor, as opposed to corporate protsand individual gazillions. Youll still be able to attend thosecharity galas and demonstrate your benevolence and

philanthropic character to your admiring public. Youll justhave to write a little bit smaller check. Scrooge McDuckwould complain but then hes swimming in it, and canafford to duck paddle to a shallower end for a while.If youre in the privileged 1%, you should be paddlingright alongside and willing to support higher taxeson carried interest, and certainly capital gainsreadjusted to existing marginal income tax rates.Stanley Druckenmiller and Warren Buffett have recentlyadvocated similar proposals. The era of taxing capital

at lower rates than labor should now end.There was a time in Pimcoland long, long ago; so long agothat it now seems like a fairytale except it wasnt. I hadcriticized a large Fortune 500 company about its balancesheet and use of commercial paper. It wasnt really meantto be company-specic but more indicative of the growingamount of leverage that our credit system wasaccommodating. The company took it personally. Sorry aboutthat. I mention it now in the age of the golden ScroogeMcDuck because another large company I shall name it

Company X to be safe is again representative of an excessthat may haunt Americas future. X is a well-knowncorporation that, to put it simply, has grown earnings andearnings per share accompanied by nearly atline revenues.This troubling trend began nearly a decade ago sales havingincreased by only 9% since 2003 barely a percentage pointa year. Its most recent quarter in 2013, as a matter of fact,showed no improvement, with revenues actually decliningby 1% instead of moving up.

Prots, however, increased because the company cutexpenses along the way. Earnings per share (EPS) did evenbetter, because X used some of its cash ow to buy backstock instead of reinvesting much of it in new plant andequipment. What struck me was not this unmasking ofcompany Xs secret sauce to elevate its stock price, but thesimilarity of this corporation to the plight of the broader U.S.and even global economy. Never have American companiessent a greater share of their sales to the bottom line. Evenwhen S&P 500 companies have witnessed a decline in

corporate earnings, as shown in Chart 1, they have stillexperienced EPS gains. X and many companies in the S&P500 are remarkably similar.

CHART 1: FINANCIAL ALCHEMY

P e r c e n

t ( % )

Source: Bianco Research, L.L.C.

Dec10

Mar11

Jun11

Sep11

Dec11

Mar12

Jun12

Sep12

Dec12

Mar13

Jun13

60

50

40

30

20

10

0

-10

S&P 500 EPS growth rate (YoY)S&P 500 net income growth rate (YoY)

S&P 500 net income vs. EPS growth rate

The U.S. economy and Company X are lookalikes as well,

perhaps even twins. Revenue growth in the U.S., for instance,can best be shown by national income or its proxy, morecommonly known as nominal GDP. While our annualizednominal GDP growth rate has been a tad better than the1% that Corporation X has shown over the past 10 years,our ve year moving average has slowed from nearly 7% to

just above 3% in recent years and struggled to do just that,as shown in Chart 2. Expenses have been cut signicantlyas the share of wages to GDP has declined from 47% to 43%


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INVESTMENT OUTLOOK | NOVEMBER 2013 3

during the past decade. Before-tax prots as a percentage ofGDP on the other hand have increased from 10% to 14%over the same period, mimicking what has happened withCompany X. And heres a rather incredible kicker to thistheoretical comparison. The U.S. economy thanks tothe Fed has been operating a 1 trillion dollar sharebuyback program nearly every year since late 2008,buying Treasuries but watching much of that moneyow straight into risk assets and common stocks insteadof productive plant and equipment. My goodness! If X

cant grow revenues any more, if X companys stock has onlygone up because of expense cutting and stock buybacks,what does that say about the U.S. or many other globaleconomies? Has our prosperity been based on moneyprinting, credit expansion and cost cutting, instead ofhonest-to-goodness investment in the real economy?

CHART 2: ECONOMYS REVENUES STALLING

8

6

4

2

0 Y O Y p e r c e n

t c h a n g e

95 97 99 01 03 05 07 09

Source: Bloomberg, as of 31 December 2009

U.S. GDP nominal dollars 5-year moving average

The simple answer is that long-term growth for eachcompany, and for all countries, depends not on balancesheet alchemy and nancial wizardry, but investment

and the ultimate demand for a company or a countrysproducts. In the U.S. we have had little of that, watchingour investment (ex housing) as a percentage of GDP declinefrom 14.6% to 12.2% over the past 13 years. Similarly, ournet national savings rate (total savings after depreciation)has sunk below ground zero over the past few years beforerebounding recently, as shown in Chart 3. Without savingsthere can be no investment. Without investment there canbe little growth.

CHART 3: SQUIRRELS NOT SAVING NUTS FOR WINTER

16

12

8

4

0

-4

P e r c e n

t ( % )

55 60 65 70 75 80 85 90 95 00 05 10

Source: Haver Analytics, as of Q3 2013

U.S. net national savings rate

President Obama just this past week nally sounded a faintalarm, mounting a campaign to bolster foreign investment inthe U.S. amidst evidence like that presented in Chart 3 thatthe U.S. is falling far behind less developed nations such asMexico in the race for investment and future productivity. Itstime for folks tofocus on doing everything we can to spurgrowth and create new, high-quality jobs, he said last Friday.

Folks? Ordinary folks, the 99%, dont have money anymore,Mr. President. The rich 1% and corporations do. Perhaps yourAdministration could focus some attention these next fewweeks and months on an effort to engage foreign investors,corporate America and the 1% in investing in the U.S. If theresnot a protable new iGIZMO or a dynamic biotechnologicalbreakthrough worthy of investment, how about simply a jointeffort between government and private enterprise in aninfrastructure bank where our third world airports, third worldcity streets and third world water systems are modernized?

And back to my original point. Developed economies workbest when inequality of incomes are at a minimum. Rightnow, the U.S. ranks 16th on a Gini coefcient for developedcountries, barely ahead of Spain and Greece. By reducing the20% of national income that golden scrooges now earn,by implementing more equitable tax reform that equalizescapital gains, carried interest and nominal income tax rates,we might move up the list to challenge more productiveeconomies such as Germany and Canada.


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Our problems are signicant, Mr. President, and Obamacare and the signingup for it is far down the list of what we need to correct in order to move in thedirection of old normal growth rates. Surely a few astute observers in Congressknow that as well. Until we can more equitably balance Scrooge McDuck taxrates to rebalance wealth and GINI coefcients, while at the same time focusingon investment in the real as opposed to the nancial economy, then theprospects for markets whatever the asset class are anything but golden.

Scrooge McDucks Speed Read

1) Growth depends on investment and investment in part depends onan equitable rebalancing of personal income taxes, capital gains andcarried interest.

2) The era of taxing capital at lower rates than labor should end.

3) Investors in the U.S. and elsewhere must look for investment in the realeconomy, not share buy-back maneuvers that articially elevate stock prices.

William H. Gross

Managing Director
http://pimco.com/http://pimco.com/

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PIMCO Nov 2013 Investment Outlook.pdf