pimco investment outlook

7/27/2019 Pimco Investment Outlook

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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 had

the privilege of riding a credit wave and a credit boom for the

past 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 good

fortune by paying higher taxes or reforming them to favor

economic growth and labor, as opposed to corporate profits

and individual gazillions. Youll still be able to attend those

charity galas and demonstrate your benevolence and

philanthropic character to your admiring public. Youll justhave to write a little bit smaller check. Scrooge McDuck

would complain but then hes swimming in it, and can

afford to duck paddle to a shallower end for a while.

If youre in the privileged 1%, you should be paddling

right alongside and willing to support higher taxes

on carried interest, and certainly capital gains

readjusted to existing marginal income tax rates.

Stanley Druckenmiller and Warren Buffett have recently

advocated 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 ago

that it now seems like a fairytale except it wasnt. I had

criticized a large Fortune 500 company about its balance

sheet and use of commercial paper. It wasnt really meant

to be company-specific but more indicative of the growing

amount of leverage that our credit system was

accommodating. The company took it personally. Sorry about

that. I mention it now in the age of the golden Scrooge

McDuck 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-known

corporation that, to put it simply, has grown earnings and

earnings per share accompanied by nearly flatline revenues.

This troubling trend began nearly a decade ago sales having

increased by only 9% since 2003 barely a percentage point

a year. Its most recent quarter in 2013, as a matter of fact,

showed no improvement, with revenues actually declining

by 1% instead of moving up.

Profits, however, increased because the company cutexpenses along the way. Earnings per share (EPS) did even

better, because X used some of its cash flow to buy back

stock instead of reinvesting much of it in new plant and

equipment. What struck me was not this unmasking of

company Xs secret sauce to elevate its stock price, but the

similarity of this corporation to the plight of the broader U.S.

and even global economy. Never have American companies

sent a greater share of their sales to the bottom line. Even

when 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&P

500 are remarkably similar.

CHART 1: FINANCIAL ALCHEMY

Percent(%)

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 instancecan best be shown by national income or its proxy, more

commonly known as nominal GDP. While our annualized

nominal GDP growth rate has been a tad better than the

1% that Corporation X has shown over the past 10 years,

our five 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 significantly

as 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 profits as a percentage ofGDP on the other hand have increased from 10% to 14%

over the same period, mimicking what has happened with

Company X. And heres a rather incredible kicker to this

theoretical comparison. The U.S. economy thanks to

the Fed has been operating a 1 trillion dollar share

buyback program nearly every year since late 2008,

buying Treasuries but watching much of that money

flow straight into risk assets and common stocks instead

of 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 global

economies? Has our prosperity been based on money

printing, credit expansion and cost cutting, instead of

honest-to-goodness investment in the real economy?

CHART 2: ECONOMYS REVENUES STALLING

8

6

4

2

0YOY

percentchange

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 each

company, and for all countries, depends not on balance

sheet alchemy and financial wizardry, but investment

and the ultimate demand for a company or a countrysproducts.In the U.S. we have had little of that, watching

our investment (ex housing) as a percentage of GDP decline

from 14.6% to 12.2% over the past 13 years. Similarly, our

net national savings rate (total savings after depreciation)

has sunk below ground zero over the past few years before

rebounding recently, as shown in Chart 3. Without savings

there can be no investment. Without investment there can

be little growth.

CHART 3: SQUIRRELS NOT SAVING NUTS FOR WINTER

16

12

8

4

0

-4

Percent(%)

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 finally sounded a faint

alarm, mounting a campaign to bolster foreign investment in

the U.S. amidst evidence like that presented in Chart 3 that

the U.S. is falling far behind less developed nations such as

Mexico in the race for investment and future productivity. Its

time for folks tofocus on doing everything we can to spur

growth 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 your

Administration could focus some attention these next few

weeks and months on an effort to engage foreign investors,

corporate America and the 1% in investing in the U.S. If theres

not a profitable new iGIZMO or a dynamic biotechnological

breakthrough worthy of investment, how about simply a joint

effort between government and private enterprise in an

infrastructure bank where our third world airports, third world

city 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. Right

now, the U.S. ranks 16th on a Gini coefficient for developed

countries, barely ahead of Spain and Greece. By reducing the

20% of national income that golden scrooges now earn,

by implementing more equitable tax reform that equalizes

capital gains, carried interest and nominal income tax rates,

we might move up the list to challenge more productive

economies such as Germany and Canada.


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Our problems are significant, Mr. President, and Obamacare and the signing

up for it is far down the list of what we need to correct in order to move in the

direction of old normal growth rates. Surely a few astute observers in Congress

know that as well. Until we can more equitably balance Scrooge McDuck tax

rates to rebalance wealth and GINI coefficients, while at the same time focusing

on investment in the real as opposed to the financial economy, then the

prospects for markets whatever the asset class are anything but golden.

Scrooge McDucks Speed Read

1) Growth depends on investment and investment in part depends on

an equitable rebalancing of personal income taxes, capital gains and

carried 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 real

economy, not share buy-back maneuvers that artificially elevate stock prices.

William H. Gross

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

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