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Bill Gross Wants You to Know That the Stock Market Has Been a Ponzi Scheme

Bond market guru Bill Gross thinks that investors are going to be disappointed by stocks in the years ahead. In fact, Bill Gross thinks that investors have fallen under the spell of a "cult of equity" and the returns from stocks over the past century are akin to a Ponzi scheme.

In his most recent investing outlook, Gross writes (emphasis original):

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 commonsensical "illogic" of such an arrangement when carried forward another century to 2112 seems obvious as well. If stocks continue to appreciate at a 3% higher rate than the economy itself, then stockholders will command not only a disproportionate share of wealth but nearly all of the money in the world!

Now before you jump to conclusions, I should note that Gross isn't using this view as a way to hype bonds as an alternative. He has a similarly dour outlook on the returns from bonds. The only thing that Gross seems truly bullish on is the potential for central banks to attempt to revive the economy through inflation-creating loose monetary policy. And Gross is definitely bearish on that.

Gross is a brilliant investor and when he speaks, the market listens. But when it comes to his view on stocks, Gross has it dead wrong.

Starting from the top
One of Gross' primary concerns is his view that the rate of return investors are expecting is vastly out of whack with what the U.S. is capable of producing in terms of GDP growth. And Gross emphasizes that, over the long term, the total return of stocks should be consistent with U.S. GDP growth (that's wrong too, but we'll get to that later).

A quick look at the companies in the Dow Jones (INDEX: ^DJI  ) index, however, shows how wrong-headed this is. Here are the four largest Dow companies and the percentage of revenue that they get from outside of the U.S.

Company Market Cap Percentage of Non-U.S. Revenue
ExxonMobil (NYSE: XOM  ) $402 billion 68%
Wal-Mart (NYSE: WMT  ) $251 billion 28%
Microsoft (Nasdaq: MSFT  ) $245 billion 47%
IBM (NYSE: IBM  ) $222 billion 65%*

Source: S&P Capital IQ.
*Non-U.S. revenue excludes non-U.S. Americas.

As you can see, these companies do a significant amount of business outside of the U.S. And while that may allow them to take advantage of higher GDP growth rates in other countries, to the extent that they're expanding their presence in other countries, their growth can easily outpace the overall economic growth of the countries they're entering.

When lower margins attack
Like many others before him, Gross points out that recent years have been kind to corporate profits as taxes have fallen and a proportionately lower amount has gone to U.S. workers. He even provides a nice chart from Haver Analytics showing that the ratio of wages to GDP has been falling since 1960(!).

There are two issues with this. First, and I'm hardly the first to point this out, while more money going to labor and taxes would have an obvious detrimental impact on corporate bottom lines, what happens to that money? Well, it ends up in the hands of workers and the government -- both of which are likely to turn around and spend it. So while profitability may get hit, that could be counteracted by more flowing to the topline.

More importantly, though, Gross implies that the lower payments to labor and resulting increased corporate profitability was a key contributor to the great stock returns in recent decades. What he overlooks is that for the first couple of decades that wages were falling -- 1960 to 1980 -- were actually pretty lackluster for stocks. The S&P 500 appreciated a mere 3.1% per year -- in nominal terms -- over that stretch.

Further, if we believe Gross' assertion that a falling ratio of wages to GDP is good for stocks, then we could reasonably assume that a rising ratio would be bad for stocks. But if we look at the decade prior to when the slide began -- 1950 to 1960 -- that was a fantastic decade for stocks, with the S&P 500 notching an average annual gain of close to 14%.

Those tricky dividends
Perhaps the key mistake that Gross makes, however, is focusing his attack on stocks on the contention that they've appreciated far more than GDP growth over the past 100 years. The problem with that stance is that stocks haven't actually done that -- they've returned appreciably more than GDP growth. The total return that he shows in his investment outlook represents both stocks' appreciation and the dividends they've paid out.

Stock market cheerleader Jeremy Siegel, who Gross called out by name in his note, pointed out the same, as did Business Insider's Henry Blodget -- in the cheekily titled post "DEAR PIMCO: Would Bill Gross Maybe Like to Update That Analysis of Stocks He Published Yesterday." Economist Brad DeLong wrote a blog post, "Bill Gross Makes a Distressingly Common Error."

Rather than managing to make a savvy point about stocks, Gross really only managed to make himself look silly and underscore for investors exactly why they need dividend-paying stocks.

The punchy postscript
After Gross' analysis hit the wires, he and Siegel exchanged some barbs in separate TV appearances. Then, in a Wednesday appearance on CNBC, Gross backpedaled a bit, noting that stocks will most likely outperform bonds over the long term and that his personal portfolio contains more stocks than bonds. What he stuck to, however, was his view that his "Siegel constant" of 6.6% annual real return for stocks (which equates to a nominal return of more than 9%), is unlikely for years to come. I haven't seen him address the issue of total returns versus stock appreciation.

Gross' bottom line may indeed be correct -- I'm certainly not budgeting on a 9%-10% return. But as Blodget points out, if he does end up being proven right, he'll be right for the wrong reasons. And in a profession where your process means everything to your long-term performance, that's a very big deal.

Looking for stocks that could help you prove Bill Gross wrong? Start with the three Dow stocks that my fellow Fools think you need to own. To find out which three stocks, grab a free copy of the special report "The 3 Dow Stocks Dividend Investors Need."

The Motley Fool owns shares of International Business Machines, Microsoft, and ExxonMobil. Motley Fool newsletter services have recommended buying shares of Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. Motley Fool newsletter services have recommended creating a synthetic long position in International Business Machines. Motley Fool newsletter services have recommended creating a bull call spread position in Wal-Mart Stores. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Matt Koppenheffer owns shares of Wal-Mart and Microsoft, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

Read/Post Comments (22) | Recommend This Article (41)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 03, 2012, at 4:03 PM, EquityBull wrote:

    If we took the advice of Gross or his right hand man Muhamed Alerian we would have missed the entire run up from 8000 to 13,000 on the dow. Alerian was saying that we were on a "sugar high" that would not and could not last. Well so far he's looking pretty wrong. Anyone who listened to him or gross missed out on some generational gains.

    Buffett has said he ignores pundits, economists and headlines. Says nobody can predict the economy or the market so why bother wasting time trying to. Buy good companies with good moats at fair or discounted prices and hold forever. If it gets cheaper you buy more. Ignore all the fear and headlines. It makes life much easier. Nobody knows what tomorrow brings. Just trust that our kids will live better than we do and their kids will live better than ours. If you cannot do this don't invest.

  • Report this Comment On August 03, 2012, at 4:53 PM, mad97123 wrote:


    Bond have out performed stocks since the 60s, so missing a recent run from from 8000 -13,000 is no worry, you are just recovering losses, and you're still below where you were in 2000! Assuming you are a real Bull.

    The other thing to remember is GDP is inflated by all the debt that built up during the bull market. As this debt bubble works it way off, expect stock to work their way lower as well, or at least stay relatively flat.

    Case/ Shiller P/Es are just now entering levels where a typical bear market starts.

    Good luck with those "generational gains" , you may be waiting a generation.

  • Report this Comment On August 03, 2012, at 4:54 PM, mad97123 wrote:
  • Report this Comment On August 03, 2012, at 6:02 PM, ilovesumm wrote:

    Well if he is so good at market reading then he can short the market and make money.

    Sounds like a case of frustrated sour grapes tho.

  • Report this Comment On August 03, 2012, at 11:05 PM, bordereiver wrote:

    With the help of Motley Fool, I have been able to stay at or around 10%, but I realize how fragile it all is with the macro events hitting us periodically. But with MF's help my target will still be 10%, and if I end up at 6% I'll probably still live. A few more DDDs or Apples (yes I'm big time long on Apple, closing my eyes when I see some of the bright people telling me that is a mistake) and maybe I'll be able to hit my 10% target.

  • Report this Comment On August 04, 2012, at 12:15 PM, rbraseth wrote:

    I believe Mr. Gross has a few flaws in his thesis. However, I believe many of the issues he brings up. Although not a Ponzi scheme, I know the stock market is not a level playing field for individual investors. A recent experience with facebook is but one example. In fact, we are faced with being mocked and laughed at. However, I like being called the "dumb" money. It's good to be underestimated. We cannot ignore Mr. Gross completely. He is a talented and decent star in the investment world. In the same breath, many of us with well chosen stocks have done just fine thank you very much.

  • Report this Comment On August 04, 2012, at 1:28 PM, Crosshair wrote:

    I believe the flaw in Gross' in reasoning is due to the fact that he fails to grasp the discounting mechanism of the stock market. Assuming top line growth of only 3%, one is still capable of generating a consistent 10% compound annual return over time if he/she is able to purchase those future cash flows (growing only at 3%) at a constant discount of 10%.

    One can even envision a compound annual return of 10% on flat or even declining growth rates, provided the investor pays the right price, i.e. purchases those future projected flat/declining cash flows discounted at 10%.

    It really concerns me that such a "financial guru" fails to grasp this central attribute of financial markets.

  • Report this Comment On August 04, 2012, at 1:36 PM, TMFMorgan wrote:

    Odd that PIMCO doesn't disclose this in the prospectus of its stock funds.

  • Report this Comment On August 04, 2012, at 1:45 PM, chitownHVAC wrote:

    so why is this guy still weighted to stocks. If i had his view I would be long GOLD & SILVER

  • Report this Comment On August 04, 2012, at 3:19 PM, chopchop0 wrote:

    This is the same guy who was bearish on US treasury bonds a couple of years ago and lost trillions for his investors because of it. Not sure I take much stock in his predictions now

  • Report this Comment On August 04, 2012, at 3:30 PM, somethingnew wrote:

    I feel very strongly that the general point Gross makes is correct and have felt this way for years wondering why it never got brought up in the mainstream investment media. Gross does make some serious errors like you pointed out but I think a better way to figure out if Gross is correct or not would be to take total World GDP and compare it to actual stock market returns plus dividends. In order to do that though you would need to get that data for the last 100 years and I'm not sure how easy it would be to obtain reliable data that far back including countries that no longer exist going back to the early 1900's. It's one thing to get that data for the U.S. only but Montenegro, the early Russian empire or a number of other "extinct" countries that nearly fill my stamp book from the early 1900's that was handed down through my family. Can we get accurate records from all these countries showing how much they contributed to profits going to US companies close to a hundred years ago? One thing to consider is that although now as Matt pointed out, Gross didn't figure in other countries contributing to U.S. profits it wasn't always that way and I'd be willing to bet a good 50 years of that data, if it were to exist, would show that a majority of the profits U.S. companies made were made in the U.S. If the stock market was a ponzi scheme think about it this way to, usually ponzi schemes go on for longer than anyone expects until they are found out. If the stock market for 50 years was basically a ponzi scheme then it's rational to say another 50 years could pass til investors realized it. The housing price bubble lasted close to a decade but it took a long time before investors realized at the end it was just all smoke and mirrors and was basically, in a sense, a ponzi scheme helped by the U.S. government.

  • Report this Comment On August 04, 2012, at 4:25 PM, xetn wrote:

    I don't completely agree with Gross, but I do believe that monetary inflation (creating money out of thin air) is more than a little responsible for the run up in stock prices. When new money is created, it does not all go to the whole economy at once, but is filtered down from first receivers (bankers, etc) to the last receivers (fixed incomers). All this new money ends up in investments such as stocks and earlier into real estate. (This has also been happening in China by the same process). The following two charts (assuming you don't just delete this post) are, although a little dated, are still illustrative:


  • Report this Comment On August 04, 2012, at 4:41 PM, Kauaicat wrote:

    I don't think Gross properly accounted for dividends, or foreign income, but one argument he COULD have made is that the official rate of inflation over the last 30 plus years has been toyed with by politicians (both parties are complicit) to the point where it is significantly different than the actual rate most consumers see, so that the inflation-adjusted real GDP is actually less than what is reported.

    And over the last 3 years, the QE and Twist monetary policies of the Fed and the ECB have changed the dynamics of the stock market to where it could be considered a Ponzi scheme. Just consider how the market reacts to the nuanced statements of Bernanke and the Fed, or Draghi and the ECB.

  • Report this Comment On August 05, 2012, at 12:45 AM, daveandrae wrote:

    There are two types of investors.

    The ones that don't know what the market is going to do "next" and the ones that don't know, that they don't know, what the market is going to do next.

    Thus, I would never, ever, value someone else's opinion over my own.

    One must never forget that journalism's #1 job is to keep you, the viewer, or the reader, coming back for more "journalism." If the media ever told you the simple truth ( buy equities-HOLD equities) you would eventually get sick of hearing it and turn it off.

  • Report this Comment On August 05, 2012, at 1:27 AM, lwbaum wrote:

    In general, over the very long term, it seems reasonable to me that global stocks can't appreciate faster than global GDP. Otherwise, eventually stocks would be worth more than all wealth. However, I suppose that stocks could increase or decrease their share of total wealth for a long but finite time by advantages over other forms of wealth. For example, if few people had access to stock markets 200 years ago, but access and cultural acceptance of stock investing increased over the centuries, there would be more demand for stocks, and P/E ratios would increase.

    Another example: if most GDP before the industrial revolution was by small farmers, stocks of corporations represented a small proportion of GDP. Now, I suppose that specialization of labor and organization of production into large units has greatly increased the proportion of GDP from medium to large corporations, which are much more likely to be represented on stock markets than are small farms. However, we will always need some of our production from individuals and small businesses, which are not listed on stock markets, thus this process will eventually stop. It's still going strong in developing countries, like India (where small-scale agriculture still makes up a huge proportion of the economy), thus it won't stop worldwide for several generations, but it's reaching equilibrium in developed countries. Thus, this temporary (centuries-long, but not permanent) boost to the share of stocks as a proportion of global wealth will gradually end.

    Until then, there's still a lot of long-term appreciation potential for stocks, particularly for companies working in developing regions. After the whole world has developed (probably after we're all dead), maybe stocks will appreciate about as much as GDP.

  • Report this Comment On August 05, 2012, at 2:42 AM, TMFMorgan wrote:

    <<In general, over the very long term, it seems reasonable to me that global stocks can't appreciate faster than global GDP. Otherwise, eventually stocks would be worth more than all wealth.>>

    GDP is an annual flow. Wealth is a capitalized sum. Wealth will always equal far more than GDP. Indeed, GDP in the US is currently around $15 trillion, while household wealth is more than $60 trillion.

  • Report this Comment On August 05, 2012, at 2:42 AM, TMFMorgan wrote:

  • Report this Comment On August 05, 2012, at 12:16 PM, enthuskeptic wrote:

    Mr Koppenheffer is a genius simply because he states the obvious: Tax revenues and a strong, well paid middle class are crucial.

    There is too much complaining about taxes and rising wages.

    If you don't belive me, just go to a bankrupt city or poor country.

  • Report this Comment On August 05, 2012, at 1:32 PM, lowmaple wrote:

    rbasreth: There will always be people throwing away money on poor IPOs, but due dilligence will keep investors out ot those pitfalls.

  • Report this Comment On August 08, 2012, at 4:05 PM, JadedFoolalex wrote:

    I'd like to know where Mr. Gross and his accolites will put their monies when interest rates start heading north!

  • Report this Comment On August 10, 2012, at 2:42 PM, whyaduck1128 wrote:

    Being a bond guru does not make one a stock guru as well. Reads to me as though Mr. Gross is starting to believe his own press clippings.

  • Report this Comment On August 12, 2012, at 7:57 PM, ZhongYing wrote:

    In the long-run, can total returns (stock appreciation and dividends) be more than the long-term growth rate of the global economy? Isn't the long-term return from dividends comes from a company's performance which in turns is dependent on the long-term growth rate of the global economy?

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