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

Matt Koppenheffer
August 3, 2012

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