Note to Bond King: Check Your Math

Tuesday, August 7th, 2012

by Seth J. Masters, AllianceBernstein

August 6, 2012

The Wall Street Journal published an article on August 1 headlined: “Bill Gross: Equities are Dead.” In fairness to Gross, what he actually wrote in his August “Investment Outlook” was, “the cult of equities is dying.” We agree with most of Gross’s argument—but not with his unsupported forecast of extremely low  stock returns.

Let’s take a look at Gross’s claims:

1) Gross notes that bonds have outperformed stocks for the last 10, 20 and 30 years. With long US Treasuries currently yielding 2.7%, it is unlikely that bonds will replicate the performance of decades past.

We agree. That is why stocks are attractive today relative to bonds. Bonds—having outperformed—are now unusually expensive and have low expected returns going forward. By contrast, stocks—having performed poorly—are cheaper than normal and are likely to significantly outperform bonds over the next 10 years.

2) Gross argues that US stocks can’t maintain their 6.6% average annualized real return over the last 100 years. The 6.6% real equity return was 3% higher than real GDP growth, with shareholders gaining at the expense of labor and government. Labor and government must demand some recompense for wealth creation, and GDP growth itself must slow due to deleveraging.

We agree. We are now in a lower return environment. The question is, how low? Let’s concede that stocks will grow in line with real GDP. Over the long haul, real GDP growth primarily reflects population (growing a little over 1%) and productivity (growing just above 2%). That would give us a projected real equity return of maybe 3%—less than half the historical 6.6% rate.

3) Gross asserts that stocks will have a nominal return of 4%.

This is where Gross’s math gets fuzzy. Why this sudden switch to nominal instead of real returns? Does Gross expect that US population will shrink, productivity gains will disappear, and inflation will remain quiescent forever? That is what needs to happen for long-term nominal GDP growth to be as low as 4%. The scenario is possible, but hardly likely. Just assuming that inflation runs at a relatively tame 3% with below-normal real GDP growth of another 3%, we’d have nominal equity returns of 6% or so. That looks quite attractive when you get just 2.7% for holding long bonds to maturity.

In our recently published paper “The Case for the 20,000 Dow,” we show that with reasonable assumptions we can get returns in the 6% to 7% range and that the Dow hits that target in five to 10 years. We will also lay out our argument in an upcoming blog post.

Most investors today are very concerned about equity volatility, and for good reason. But there is another risk that should concern investors: the risk that their investments will not keep up with inflation and meet their goals. As investors balance short-term market risk against the long-run risk of falling short of their objectives, we think an appropriate allocation to equities continues to improve the likelihood for success.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Seth J. Masters is Chief Investment Officer of Asset Allocation and Defined Contribution Investments at AllianceBernstein and Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein.

Tags: Alliancebernstein, August 1, Bill Gross, Bonds, Equity Return, Fairness, GDP, GDP Growth, Government Labor, inflation, Investment Outlook, Productivity Gains, Real Gdp, Recompense, Seth, Stock Returns, Treasuries, Wall Street Journal, Wealth Creation
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When did Austerity Become a 4 Letter Word? (Tchir)

Friday, April 27th, 2012

by Peter Tchir, TF Market Advisors

Suddenly, everywhere you look, “austerity” has become a 4 letter word. Clearly it wasn’t excessive spending that caused too much debt. Surely we didn’t hit a financial crisis in spite of excessive spending, nope, it is all the fault of austerity.

In the rush to avoid supporting anything that could be viewed as “austerity” we have lost sight of what austerity is, and how it can impact the economy.

Is pushing the retirement age from 55 to 57 “austerity”? I don’t see how making decisions like this is bad. It has very little impact on the economy today, yet is a crucial step to creating long term fiscal balance.

Is cutting retirement benefits, starting in 5 years “austerity”? Once again, the near term impact is minimal, and while painful, is a necessary step towards long term sustainability.

Is firing government employees “austerity”? While necessary in the long term, the immediate impact on the economy may not be worth it. Maybe bloated governments need to be dealt with, but over time.

Are programs designed to enforce the tax code “austerity”? Collecting these taxes will take money out of current spending, but the people holding this money by not following the tax laws don’t deserve to have it. It is necessary to create a culture of fairness. This is money that was supposed to be the government’s anyways. You might not like what the government does with the money (do any of us?), but programs that enforce existing tax codes should not be cancelled.

Are unemployment benefits “austerity”? This gets a lot trickier. The short term impact would be to take money out of the economy, as people are likely spending this money as they get it. Yet, if the benefits are too good, are people choosing unemployment with benefits over work?

Are cuts to health care “austerity”? A very touchy subject, yet the reality is this is an area that needs to be addressed. There has to be a balance between ensuring people can have access to great healthcare and that the system is sustainable and the cost/benefits don’t get out of control. In Greece, doctor’s were force to file things electronically or risk not getting paid. Funny how quickly doctor’s were able to computerize their offices, bringing costs lower, in spite of what looked like an “austerity” program.

So, let’s not let politicians get away with claiming everything that is “austerity” is bad. It isn’t. Some forms of “austerity” have minimal near term impact yet are crucial for the long run.

Then let’s look at the long run. Dr. Krugman had a piece today that highlighted the correlation between “austerity” and GDP growth. It showed that more “austerity” (however it was defined) meant slower growth. Doesn’t take a PhD to figure out that GDP is consumption based, and a cut in spending would reduce GDP.

What this chart, and so many other fails to do, is analyze what the impact is two years down the road. Countries were all busy spending throughout the 2000′s and here we are with a debt crisis. Too much debt is impeding the ability to grow. If a farmer planted a seed and the next day gave up in disgust because there were no crops to harvest, we wouldn’t have any food. Programs and policies take time. It is obvious that spending provides a bigger short term boost than cutting spending. It is far less obvious, that a year from now, the adjustments made to deal with the spending cuts won’t create a better future.

We too often confused “conjecture” with “fact”. Lately I have seen a lot written about how much better the job situation is today than it would have been without all the policies of Obama, Geithner, and Bernanke. It is treated as fact, yet it is merely conjecture. I will admit in the quarter the policies were applied, it made the situation in that quarter better than it was. We cannot know whether we are better off now than had we followed some alternative path. Maybe waiting to apply the policies would have created a bigger effect – the “wait until you see the white’s of their eyes” theory. Maybe allowing more banks to fail would have created a wave of new lending institutions that aren’t in competition with subsidized zombie banks. We don’t know. Economics is guess work. There are competing reasons in economics because with some data, some math, some simplifications, and some logic, both sides of a coin can sound good. The theories can’t be put to a proper test. There are no 3 identical economies where you can leave one alone (the control) and apply the competing theories to the other 2 economies and see which theory is correct.

We need to take a longer term view to determine the best solution and we need to critically analyze what has been done and not just assume alternative paths would have led to a worse current situation.

E-mail: tchir@tfmarketadvisors.com

Twitter: @TFMkts

Tags: Austerity, Economy, Fairness, Financial Crisis, Fiscal Balance, Government Employees, Governments, Health Care, Letter Word, Nbsp, Necessary Step, Retirement Age, Retirement Benefits, Rush, Spite, Term Impact, Term Sustainability, Tf, Touchy Subject, Unemployment Benefits
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ETFs Better Than Mutual Funds For Long-Term Investors

Sunday, June 13th, 2010

This article is a guest contribution by Matt Hougan, IndexUniverse.com.

John Bogle is wrong: Exchange-traded funds are actually the best available tool for long-term investors. Better, by far, than mutual funds.

I had this realization the other day when I was speaking about ETFs at a symposium organized by Vanguard. Anytime I put Vanguard and ETFs together, I’m reminded of the fact that Bogle, Vanguard’s founder, dislikes ETFs with a passion rarely seen in the indexing community.

A year ago, Bogle presented data at our annual Journal of Indexes board meeting showing that the average dollar invested in ETFs dramatically underperformed the ETF itself. In other words, investors had a tendency to buy high and sell low.

Bogle’s argument was built on imprecise data, but I’m not going to reopen that. For purposes of this blog, I’m less concerned with the experience of the average investor than the experience of investors who use ETFs correctly. And for those investors, there’s no question: ETFs aren’t just equivalent to mutual funds, they’re qualitatively better.

Usually, when people make this argument, they focus on the fact that ETFs are, by and large, cheaper than mutual funds. While true in general, it’s almost irrelevant. Some institutional mutual funds have lower expense ratios than any ETF. Also, ETF investors bear additional costs in terms of commissions and bid/ask spreads, which mutual fund investors don’t pay.

On costs alone, it’s a tossup.

Where ETFs truly excel—where they are definitively superior to mutual funds—is on fairness.

When you buy a mutual fund, you’re exposed to the actions of others. For instance, if you buy shares in the Growth Fund of America, and then half of the investors in the fund decide to redeem out of their positions, you will bear the brunt of the trading costs as the fund sells stocks to meet those redemptions. If any capital gains are incurred, you will pay those gains, even though you didn’t sell a share and had no intention of exiting your position.

If, on the other hand, no one sells, but another $10 billion in investor cash comes into the fund, you have to pay your share of the costs of putting that money to work: the commissions, the trading spreads, the market impact, etc.

With ETFs, the only thing that matters is you. Outside of a small number of bond funds and a few alternative asset products—such as Vanguard’s ETFs, which share classes of broader mutual funds— existing investors are completely shielded from the actions of others either entering or exiting the ETF. No paying for other people’s commissions, no paying for other people’s market impact and, by and large, no capital-gains distributions driven by the actions of others.

Your investment return and tax profile are driven by your actions, and that’s it.

This may seem like a minor detail, but if you’re investing for 10 or 20 years, those details add up.

I understand Bogle’s concerns about ETFs. Too many people trade them way too often, racking up big costs and they often shoot themselves in the foot trying to time the market.

But the beauty of the ETF structure is that if you’re a long-term investor, none of that matters. It’s just noise.

For the long-term investor, ETFs are the fairer investment, and they should generally deliver stronger after-tax returns.

The low, low costs don’t hurt either.

Copyright (c) IndexUniverse.com

Tags: Board Meeting, Brunt, Capital Gains, Commissions, ETF, ETFs, Exchange Traded Funds, Expense Ratios, Fairness, Hougan, Imprecise Data, Indexes, Indexuniverse, Institutional Mutual Funds, John Bogle, Mutual Fund Investors, Realization, Redemptions, T Pay, Term Investors, Vanguard
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Ayn Rand: Atlas Shrugged Prophetic?

Friday, November 13th, 2009

A new book by Anne Heller about Ayn Rand, and her philosophy of objectivism is making rounds these days, re-igniting the relevance and debates about Rand’s 1957 bestseller “Atlas Shrugged.”

Like many others before, the first time I read Atlas Shrugged it changed my life. It clarified my understanding of the world we live in, of the business world, of markets, and particular spoke to me about the obstacles of starting and building a business, and the kinds of people who could either help or hinder the entrepreneurial process. If you have not read it, you should. It is a great and epic story of what Rand felt was going wrong in America, and to a very large degree, it has been prophetic of the economic collision we are currently facing.

In her preface, Heller notes “Because most readers encounter her (Rand) in their formative years, she has had a potent influence in three generations of Americans.” I was 15 when a friend lent me The Fountainhead (he let me keep the book, a Signet paperback costing $3.50). I liked the novel, but was mystified by Dominique and Roark’s relationship. Though impressed by Anthem and We the Living, it was Atlas Shrugged that knocked me sideways.

If you are at all entrepreneurial about your business, Atlas Shrugged will clarify the world for you, move you, and speak to you.

In a Wall Street Journal column, last year Stephen Moore discussed the prophetic nature of Rand’s 50 year old multi-decade bestseller.

For the uninitiated, the moral of the story is simply this: Politicians invariably respond to crises — that in most cases they themselves created — by spawning new government programs, laws and regulations. These, in turn, generate more havoc and poverty, which inspires the politicians to create more programs . . . and the downward spiral repeats itself until the productive sectors of the economy collapse under the collective weight of taxes and other burdens imposed in the name of fairness, equality and do-goodism.

In the book, these relentless wealth redistributionists and their programs are disparaged as “the looters and their laws.” Every new act of government futility and stupidity carries with it a benevolent-sounding title. These include the “Anti-Greed Act” to redistribute income (sounds like Charlie Rangel’s promises soak-the-rich tax bill) and the “Equalization of Opportunity Act” to prevent people from starting more than one business (to give other people a chance). My personal favorite, the “Anti Dog-Eat-Dog Act,” aims to restrict cut-throat competition between firms and thus slow the wave of business bankruptcies. Why didn’t Hank Paulson think of that?

These acts and edicts sound farcical, yes, but no more so than the actual events in Washington, circa 2008. We already have been served up the $700 billion “Emergency Economic Stabilization Act” and the “Auto Industry Financing and Restructuring Act.” Now that Barack Obama is in town, he will soon sign into law with great urgency the “American Recovery and Reinvestment Plan.” This latest Hail Mary pass will increase the federal budget (which has already expanded by $1.5 trillion in eight years under George Bush) by an additional $1 trillion — in roughly his first 100 days in office.

The current economic strategy is right out of “Atlas Shrugged”: The more incompetent you are in business, the more handouts the politicians will bestow on you. That’s the justification for the $2 trillion of subsidies doled out already to keep afloat distressed insurance companies, banks, Wall Street investment houses, and auto companies — while standing next in line for their share of the booty are real-estate developers, the steel industry, chemical companies, airlines, ethanol producers, construction firms and even catfish farmers. With each successive bailout to “calm the markets,” another trillion of national wealth is subsequently lost. Yet, as “Atlas” grimly foretold, we now treat the incompetent who wreck their companies as victims, while those resourceful business owners who manage to make a profit are portrayed as recipients of illegitimate “windfalls.”

I found this speech by Comcast Spectacor Chairman, Ed Snider, in which he describes how as an entrepreneur, Atlas Shrugged changed his life and the lives of his children, that he went on to found the Ayn Rand Institute, in order to foster teaching Rand’s Objectivism in universities across America, because he saw that so many young Americans were clueless about entrepreneurism let alone what capitalism once was.

Part 1 – 9:13 minutes

Part 2 – 2:21 minutes

Also, if it interests you, here is the original footage of Ayn Rand’s 1959 interview with Mike Wallace:

Part 1:

Part 2:

Tags: Ayn Rand, Burdens, Business World, Collapse, Crises, Downward Spiral, Fairness, Formative Years, Fountainhead, Government Programs, Havoc, Moral Of The Story, Objectivism, Productive Sectors, Roark, Sectors Of The Economy, Signet Paperback, Stephen Moore, Three Generations, Wall Street Journal
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