Returns on Stocks Going Forward: Will our Generation ever Retire?

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Bill Gross, the famous bond manager who founded PIMCO, has a new article out where he argues that we shouldn't expect much in the way of equity returns over the next few decades.

Although you might think that he would use this as a chance to plug bond investing, you'd be wrong: he doesn't think that bonds will fare much better, and we'll instead see central banks try to inflate their way out of the problem going forward.

This article really got me thinking about the broader implications of living in a world where the premium for investing in equities is very uncertain. We (people in our 20's-30's) won't have the pensions and stable, 30 year jobs that our "Greatest Generation" grandparents did, and it's far from certain that we'll have the explosive equity returns that our "Baby Boomer" parents did. In spite of this, however, I'm very optimistic about our generation's ability to find meaningful, substantive work even if it means less assurance of a conventional career path.

Going back to Gross's original article for a second, he starts off by arguing that it's going to be difficult to realize a 6.6% future equity return going forward because the historical situation that created those returns was particularly favorable to capital---and we can't expect that to continue going forward...

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 legitimate question that market analysts, government forecasters and pension consultants should answer is how that 6.6% real return can possibly be duplicated in the future given today's initial conditions which historically have never been more favorable for corporate profits. If labor and indeed government must demand some recompense for the four decade's long downward tilting teeter-totter of wealth creation, and if GDP growth itself is slowing significantly due to deleveraging in a New Normal economy, then how can stocks appreciate at 6.6% real? They cannot, absent a productivity miracle that resembles Apple's wizardry.

And he's not much more optimistic about bonds...

With long Treasuries currently yielding 2.55%, it is even more of a stretch to assume that long-term bonds - and the bond market - will replicate the performance of decades past...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.

The main "out" that Gross sees is governments inflating the problem away, which of course has the potential to be very destructive:

The primary magic potion that policymakers have always applied in such a predicament is to inflate their way out of the corner. The easiest way to produce 7-8% yields for bonds over the next 30 years is to inflate them as quickly as possible to 7-8%! Woe to the holder of long-term bonds in the process! Similarly for stocks because they fare poorly as well in inflationary periods. Yet if profits can be reflated to 5-10% annual growth rates, if the U.S. economy can grow nominally at 6-7% as it did in the 70s and 80s, then America's and indeed the global economy's liabilities can be "reflated" away.

Although there have been some good critiques of Gross's point on Seeking Alpha and from Jeremy Siegel, I think that it's still reasonable to assume that it will be much more difficult for individuals, families, pension managers, and governments to make long term investing plans when there are so many compelling reasons to think that the historical 6-7% equity premium won't persist going forward.

The ongoing financial crisis has already caused people to postpone retirement, or has perhaps put individuals in a position where retirement isn't even a possibility--I've seen this in my own family. Job growth is still anemic, and many underemployed recent grads may never be able to fully catch up. I don't think that the traditional model of working for a set number of years before retiring will be nearly as common in the future as employment lengths and salaries become more volatile.

But is this such a terrible thing? Perhaps not entirely. Anecdotally, I think that my generation (mid-20's) has less overall desire to follow the traditional path of climbing the corporate ladder and then retiring at a set time. I would bet that just as many people at top schools want to work at a startup as a large corporation. And the internet is making it much easier to work remotely on project work or other tasks. I think that going forward we'll see more flexible work arrangements and hours, though the price that we'll pay for that will be in the form of less security and more income volatility.

Monkeys, what do you think the "workplace" will look like 20-30 years from now? Do you think that you'll "retire" in the same way that the American "Greatest Generation" did? How do you think that investment fund managers will deal with this a world with more volatile asset returns?

Comments (25)

Aug 5, 2012

I think it's dumb to predict, economists can't get one-year GDP growth right, yet we have people speculating on how innovative and productive the corporate sector will be in long-term. People in 1960s didn't believe USSR would collapse and in 1980s no one thought China would become a bigger economy than Japan.

Aug 5, 2012

No mention of the housing market? I would think that's a huge determinant of how the future will play out.

Baby you're the perfect shape, baby you're the perfect weight. Treat me like my birthday, I want it this way and I want it that way. It makes a man feel good baby.

Aug 5, 2012

You forgot to mention that social security is going to go bankrupt and we are only going to get pennies on the dollar of our original (forced) investment.

Aug 5, 2012
Amphipathic:

You forgot to mention that social security is going to go bankrupt and we are only going to get pennies on the dollar of our original (forced) investment.

A forced investment should just be considered a sunk cost... if you're under 30 don't even expect pennies on the dollar, expect a huge middle finger from your government (if you don't already)

Aug 5, 2012
BlackHat:
Amphipathic:

You forgot to mention that social security is going to go bankrupt and we are only going to get pennies on the dollar of our original (forced) investment.

A forced investment should just be considered a sunk cost... if you're under 30 don't even expect pennies on the dollar, expect a huge middle finger from your government (if you don't already)

Same--I'm not counting on SS in the coming years. I worry, though, if too many people adopt this attitude that it will just become a self-fulfilling prophecy: nobody expects to get much, so politicians don't feel the need to provide it to the voters.

Aug 5, 2012
Amphipathic:

You forgot to mention that social security is going to go bankrupt and we are only going to get pennies on the dollar of our original (forced) investment.

SS is in surplus till 2030. Movement conservatives have been trying to bankrupt it since the 80s. The Feds owe SS fund trillions.

The only way out of the reccession is to bring down food, college and dollar inflation ( stop QE and subsiding Biofuels) and do what the germans did ban higj frequency trading . Take steps to regain the political system from big money.

Devolve more money and powers to the states

Aug 5, 2012
jam011:
Amphipathic:

You forgot to mention that social security is going to go bankrupt and we are only going to get pennies on the dollar of our original (forced) investment.

SS is in surplus till 2030. Movement conservatives have been trying to bankrupt it since the 80s. The Feds owe SS fund trillions.

The only way out of the reccession is to bring down food, college and dollar inflation ( stop QE and subsiding Biofuels) and do what the germans did ban higj frequency trading . Take steps to regain the political system from big money.

Devolve more money and powers to the states

Through the end of 2010, the federal government owed the SS trust fund $2.6 trillion. Obama has added more than $5 trillion to the national debt in less than 4 years as president. Not sure how "movement conservatives" bear the sole responsibility for profligate spending on Democrat programs.

SS isn't even the problem. Medicare is the primary problem with the U.S. retirement system. Medicare is unfunded by multiple DOZENS of trillions of dollars. I've seen estimates that the Medicare unfunded liability could be anywhere from $39 trillion to $100 trillion. Those numbers are staggering! But what's worse is that the federal government can actually remove these liabilities in one fell swoop of the pen--which means politicians today can make promises to people today, stay in power, and then when the sh*t hits the fan (Medicare's dooms day is before 2020) they can just renege on the promises to the voters.

Aug 5, 2012

Why is 6-7% equity returns unsustainable in a 3.5% GDP growth environment? GDP growth is not entirely fueled by equity investment and is a leveraged growth rate funded by debt that requires lower expected return than 3.5%. Anyone care to argue this?

Aug 5, 2012
HarvardOrBust:

Why is 6-7% equity returns unsustainable in a 3.5% GDP growth environment? GDP growth is not entirely fueled by equity investment and is a leveraged growth rate funded by debt that requires lower expected return than 3.5%. Anyone care to argue this?

Jeremy Siegel and others have criticized this (I embedded some links in the original post) on the grounds that the historical 6.6% premium includes dividends, much of which are spent on current consumption. It's not clear to me that equity total returns >> GDP growth is "unsustainable" either, though I would be interested in hearing from other people on this as well.

Aug 5, 2012
Hayek:
HarvardOrBust:

Why is 6-7% equity returns unsustainable in a 3.5% GDP growth environment? GDP growth is not entirely fueled by equity investment and is a leveraged growth rate funded by debt that requires lower expected return than 3.5%. Anyone care to argue this?

Jeremy Siegel and others have criticized this (I embedded some links in the original post) on the grounds that the historical 6.6% premium includes dividends, much of which are spent on current consumption. It's not clear to me that equity total returns >> GDP growth is "unsustainable" either, though I would be interested in hearing from other people on this as well.

Without investor confidence, the stock market will continue to stagnate. The 6-7% returns require that investors consistently invest their money. If average Joe has lost confidence in the markets and chooses to put their money in other investments, the market cannot grow. It is essentially a Ponzi scheme.

Aug 5, 2012

Henry Blodget has an excellent critique of Bill Gross's returns calculations:

http://www.businessinsider.com/why-bill-gross-is-w...
"Where Mr. Gross stumbles is on dividends, which actually account for the MAJORITY of the long-term inflation adjusted return.

Dividends are cash that companies pay out to shareholders.

The shareholders do not generally keep this money.

Rather, the shareholders use the money to buy more shares--in which case the cash goes to someone else--or they use it to buy stuff.

Either way, the cash gets recirculated back into the economy. It becomes revenue for other companies and salaries for other people. And a small bit of it then gets temporarily captured as "profit" by other companies and paid out to their shareholders. At which point the cash begins circulating again.

The point is that the biggest contributor to long-term stock returns--the 4% dividend payout--is not hoarded forever by equity shareholders. It is spent. So, far from allowing stockholders to collectively "skim off" 7% wealth appreciation per year in an economy only growing at 3%, the dividends are merely cash that gets passed around and circulated back into the economy.

And, contrary to what Mr. Gross asserts, companies can absolutely return more in dividends than GDP growth in perpetuity..."

Aug 5, 2012

I wasn't referring to dividends. Think of the US as a company with a levered capital structure. The company can grow 3% a year but have its equity grow 6% because of leverage.

Aug 5, 2012

People shouldn't retire until they are physically or mentally incapable, including the super rich. Retirement is a disease propigated by socialists who have created fiscally unsunstainable models to realize these dreams. Retirement has been demonstrated to be bad for the elderly's mental state and it is generally unsustainable fiscally. It's one of those cases where the mathematics--fiscal, financial and demographic math--indicates that retirement is an unnatural state that should not be the goal of a society.

Aug 5, 2012
Virginia Tech 4ever:

Retirement is a disease propigated by socialists

^^^hahahaha^^^

Aug 5, 2012
SirPoopsaLot:
Virginia Tech 4ever:

Retirement is a disease propigated by socialists

^^^hahahaha^^^

To be fair, retirement is not something this species is particularly good at doing. Delayed gratification is something most of us are terrible at and for the average American it is 10x worse. People don't understand how much money they need to retire, let alone know how much to save or where to invest it.

Company pensions were good for many people given that they were basically forced savings and professionally managed. Most people are not hard wired to save. Things like automatic enrollment in 401k plans with automatic escalations are a good start. Pensions aren't coming back in the private sector in any of our lifetimes.

As far as forward returns on the US stock market: of course they will be lower than historical averages. If you take the stock market returns starting in 1900 until now, you are basically looking at the transformation of a borderline emerging market into the most powerful country in the history of the world, both in economic output and military might (America, fuck yeah!). That won't happen again. The average equity risk premium across countries over time is about 4% over govt bonds. That is a good point of comparison for us here. Given that I believe that US Treasuries are overvalued, we are probably looking at average returns of about 8% in the US equity market over the next twenty years or so.

Aug 6, 2012
Virginia Tech 4ever:

People shouldn't retire until they are physically or mentally incapable, including the super rich. Retirement is a disease propigated by socialists who have created fiscally unsunstainable models to realize these dreams. Retirement has been demonstrated to be bad for the elderly's mental state and it is generally unsustainable fiscally. It's one of those cases where the mathematics--fiscal, financial and demographic math--indicates that retirement is an unnatural state that should not be the goal of a society.

I'll give you this. I used to work with this guy who was in his 80's (yes he is still alive as I write this). Guy is a millionaire. Shows up to work everyday. Someone brought up his retirement during a small lunch meeting and he said that he didn't want to retire because all of his friends that did retire died. I want to live is what he said.

Aug 5, 2012

Goddamn it. I knew I spelled that word wrong--propagated. It even looked wrong but I left it. Grr. That's my biggest pet peeve!

Aug 6, 2012

Wow, you're in complete partisan denial. Obama's deficit spending has been the worst in American history. He's added more than $5 trillion to the national debt, which included a $1 trillion omnibus "stimulus" bill that was entirely and completely voluntarily entered into by the Democrats without a single Republican vote. He's had the chance to address $100 billion per year in Medicare and SS waste, fraud and abuse and has done nothing. He's not even remotely addressed the issue of entitlements other than to demagogue the issue. And Obamacare, after rolling back Medicare cuts, is scheduled to cost another $100 billion more than revenue taken in--every year! And Obama's discretionary spending increases have been something like 5 times the rate of inflation!

You're obviously a complete partisan hack. As a conservative, I can readily admit that George W. Bush was an incompetent, left-wing hack who took our finances on the road to Hell. But any rational observer can see that Barack Obama is George W. Bush on steroids.

Aug 6, 2012
Virginia Tech 4ever:

Wow, you're in complete partisan denial. Obama's deficit spending has been the worst in American history. He's added more than $5 trillion to the national debt, which included a $1 trillion omnibus "stimulus" bill that was entirely and completely voluntarily entered into by the Democrats without a single Republican vote. He's had the chance to address $100 billion per year in Medicare and SS waste, fraud and abuse and has done nothing. He's not even remotely addressed the issue of entitlements other than to demagogue the issue. And Obamacare, after rolling back Medicare cuts, is scheduled to cost another $100 billion more than revenue taken in--every year! And Obama's discretionary spending increases have been something like 5 times the rate of inflation!

You're obviously a complete partisan hack. As a conservative, I can readily admit that George W. Bush was an incompetent, left-wing hack who took our finances on the road to Hell. But any rational observer can see that Barack Obama is George W. Bush on steroids.

where are you getting these numbers from? ive seen at least 5 separate sets of data which have shown that obama spent the most, or that bush spent the most, or that obama spent just as much.

shit like that.

i want actual numbers from a reputable source

Aug 6, 2012
the magnum:
Virginia Tech 4ever:

Wow, you're in complete partisan denial. Obama's deficit spending has been the worst in American history. He's added more than $5 trillion to the national debt, which included a $1 trillion omnibus "stimulus" bill that was entirely and completely voluntarily entered into by the Democrats without a single Republican vote. He's had the chance to address $100 billion per year in Medicare and SS waste, fraud and abuse and has done nothing. He's not even remotely addressed the issue of entitlements other than to demagogue the issue. And Obamacare, after rolling back Medicare cuts, is scheduled to cost another $100 billion more than revenue taken in--every year! And Obama's discretionary spending increases have been something like 5 times the rate of inflation!

You're obviously a complete partisan hack. As a conservative, I can readily admit that George W. Bush was an incompetent, left-wing hack who took our finances on the road to Hell. But any rational observer can see that Barack Obama is George W. Bush on steroids.

where are you getting these numbers from? ive seen at least 5 separate sets of data which have shown that obama spent the most, or that bush spent the most, or that obama spent just as much.

shit like that.

i want actual numbers from a reputable source

CNS news citing the U.S. Treasury on the national deficit:

http://cnsnews.com/news/article/5-trillion-man-deb...
Obama in 39 months adds more to the national debt than Bush does in 96 months. Bush was a terrible President, and Obama is even worse on fiscal matters.

In 2010, discretionary spending was up 27%! Twenty...seven...percent. Twenty...seven...percent.

http://www.factcheck.org/2011/02/budget-spin/
Cost of the stimulus, with interest, is going to be close to $1.2 trillion.

http://money.cnn.com/2009/01/27/news/economy/stimu...
The Obamacare number is a floating target--I'm seeing a lot of different numbers for it. But you can bet your bottom dollar that Obamacare, a bloated federal bureaucracy, is not going to be anywhere nearly as cost effective as advertised. See CBO cost estimate of Obamacare went from $940 billion to $1.76 trillion over 10 years. That's a pretty egregious error made by the CBO in 2010 when the Democrats were corruptly arguing the cost benefits of Obamacare.

http://news.yahoo.com/cbo-obamacare-price-tag-shif...
Medicare itself claims that $48 billion each year is lost to waste, fraud and abuse, but many believe its much more. Some estimate that it's as high as $100 billion, and this doesn't even include Social Security waste, fraud and abuse.

http://www.socialsecuritywaste.org/SS%20Issues.htm

Aug 6, 2012
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