Your Global Investment Authority
With the budget and debt ceiling
crises temporarily averted, perhaps
a future economic priority will be to
promote economic growth; one way
to do that may be via tax reform.
How to proceed depends as always
on the view of the observer and whether the glasses are
worn by capital, labor or government interests.
Having beneﬁted enormously via the leveraging of capital since the beginning
of my career and having shared a decreasing percentage of my income thanks
to Presidents Reagan and Bush 43 via lower government taxes, I now ﬁnd my
intellectual leanings shifting to the plight of labor. I often tell my wife Sue it’s
probably a Kennedy-esque type of phenomenon. Having gotten rich at the
expense of labor, the guilt sets in and I begin to feel sorry for the less well-off,
writing very public Investment Outlooks that “dis” the success that provided
me the soapbox in the ﬁrst place. If your immediate reaction is to nod up
and down, then give yourself some points in this intellectual tête-à-tête. Still,
I would ask the Scrooge McDucks of the world who so vehemently criticize
what they consider to be counterproductive, even crippling taxation of the
wealthy in the midst of historically high corporate proﬁts and personal income,
to consider this: Instead of approaching the tax reform argument from the
standpoint of what an enormous percentage of the overall income taxes
the top 1% pay, consider how much of the national income you’ve been
privileged to make. In the United States, the share of total pre-tax income
accruing to the top 1% has more than doubled from 10% in the 1970s to
20% today. Admit that you, and I and others in the magniﬁcent “1%” grew
up in a gilded age of credit, where those who borrowed money or charged
fees on expanding ﬁnancial assets had a much better chance of making it to
the big tent than those who used their hands for a living. Yes I know many
of you money people worked hard as did I, and you survived and prospered
where others did not. A fair economic system should always allow for an
opportunity to succeed. Congratulations. Smoke that cigar, enjoy that
Chateau Laﬁte 1989. But (mostly you guys) acknowledge your good fortune
2 NOVEMBER 2013 | INVESTMENT OUTLOOK
at having been born in the ‘40s, ‘50s or ‘60s, entering the
male-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 it’s 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. You’ll still be able to attend those
charity galas and demonstrate your benevolence and
philanthropic character to your admiring public. You’ll just
have to write a little bit smaller check. Scrooge McDuck
would complain but then he’s swimming in it, and can
afford to duck paddle to a shallower end for a while.
If you’re 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 wasn’t. I had
criticized a large Fortune 500 company about its balance
sheet and use of commercial paper. It wasn’t 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 excess
that may haunt America’s 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 cut
expenses 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 X’s 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 still
experienced EPS gains. X and many companies in the S&P
500 are remarkably similar.
CHART 1: FINANCIAL ALCHEMY
Source: Bianco Research, L.L.C.
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 instance,
can 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%
INVESTMENT OUTLOOK | NOVEMBER 2013 3
during the past decade. Before-tax proﬁts as a percentage of
GDP on the other hand have increased from 10% to 14%
over the same period, mimicking what has happened with
Company X. And here’s 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
can’t grow revenues any more, if X company’s stock has only
gone 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: ECONOMY’S REVENUES STALLING
‘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 country’s
“products.” 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
‘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. “It’s
time for folks to…focus on doing everything we can to spur
growth and create new, high-quality jobs,” he said last Friday.
Folks? Ordinary folks, the 99%, don’t 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 there’s
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 work
best 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
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