Wednesday, August 8, 2012

PIMCO's Bill Gross and Other Contrarian Indicators

The other day I read an article by Bill Gross of PIMCO about the death of equities. The general gist of the article is that times are uncertain, world is in a ton of debt, etc. and equities are destined to return a real rate equal to GDP growth -- GDP tends to run at the 2-3% range.  If not then, Gross says, owners of equity will own the world if given enough time. Gross assumes that every investment penny earned over the GDP will be reinvested and will earn returns at this higher-than-GDP rate. But that is not the case, we do not reinvest everything we earn from investments, we also spend the money and enjoy fruits of wealth.  People who do not have so much wealth will not leave a rich estate to their children. They will typically use up all their money when they die.  Therefore, they do not fit in that model of forever investing, making capital gains and reinvesting all their dividends.

This counter argument of mine is not original, it has been mentioned in the media.  But what is most notable to me is that this highly public statement is a classic contrary indicator.  It is almost a reprise of the 1979 Newsweek article on the death of equities.

Mind you, Gross has been dismissed during the mid to late 2000's for sticking to bonds when equities were high fliers. Credos to him for sticking to his views.  But now it is precisely the reason that he was right about bonds for the previous 30 years, that we should discount his views now. He was right for 30 years, so he can't possibly be right for another 30! The market ebbs and flows around a baseline, what statisticians call reversion to the mean.  Bond and stock returns will be no exception.

Jeremy Grantham  of GMO is another notable money manager who feels that we will have very low market returns in the coming decade. Again he is one who's bearish views were right for the last 10-20 years. But I look at the world, and I mean really step back and look at the world income distribution, we have 20% of the world living in abject poverty, meaning $1 a day.  We have global environmental problems from global warming to destruction of rain forests. We have many parts of the world plagued with ethnic and religious strife. Much of these conflicts can be traced to poverty or lack of economic opportunities. All these problems are waiting for entrepreneurs to solve. These entrepreneurs are motivated by the profit motive like all people. They will not invest their efforts or money when the return is the 2-3% of GDP. Suppose for example, silicon valley pre-IPO investors were told they collectively will expect 2-3%?  They wouldn't both to invest! Hence the supply of able entrepreneurs will dry up.  Then guess what, no Google, no Cisco, no Microsoft. When an person can make a steady income at a large corporation, and society offers that person the alternative of 2-3% return on his invested capital to be an entrepreneur, he/she wouldn't bother.

Our capitalist society will give entrepreneurs and innovators and creative people in business the financial incentive to solve our world's problems, and we need solutions for the foreseeable future.

It is a combination of this line of thinking and just the pervasive pessimism in the market that makes me very bullish for the short term. By short term, I mean in the coming 6 to 18 months.  I wouldn't be surprised the S&P challenges its all time high of 1552 in this period. Don't laugh, it is only 10% away at the 1404 closing today.

And so in closing, I will be increasing my long position on the market.

ps. If you haven't I strongly recommend reading the "Death of Equities" in Businessweek for a real sense of perspective.

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