Thursday, August 2, 2012

"Why Bill Gross is Wrong: Innovation and Long-term Returns on Equity"

Just your favorite Pollyanna aren't I?
In the tab next to this one is a piece from Knowledge@Wharton, "Dealing with Natural Disasters, and Beyond". Next to that is another K@W piece, .
So no, I'm not Little Miss Optimism.
Take what emotional uplift you can from this post but remember: From current levels long-haul equity returns are going to be tough to come by and will require P/E multiple expansion as well as earnings growth.
From Mandel on Innovation and Growth:
Bill Gross of Pimco has just written a piece where he argues that the real return on stocks in the future will be much lower than the long-term historical average of 6.6%:
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)?
He then goes on to argue that:
The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned.
In a world of slow innovation, Gross is likely to be correct.  The economy grows slowly, and it becomes difficult to justify compensating risk capital if risks are not paying off.
The calculation changes, however, if we have big disruptive innovations. Big disruptive innovations offer risk on both the upside and the downside. On the upside, disruptive innovations create a wave of high-growth companies that drive the stock market higher. On the downside, disruptive innovations offer the distinct possibility of driving existing companies out of business, once again accentuating risk.

Innovation also makes diversification across a portfolio of large stocks a much less appealing prospect, since much of the stock gains will come from small companies that grow quickly....MORE
HT: Real Time Economics 

That last bit regarding small companies is one of the great challenges of a portfolio manager. Most of the companies that lead the way are private and thus not available outside of venture capital.

Readers who have been with us for a while know the mantra: "The next secular bull market will be fueled by some combination of materials science, advanced manufacturing and nanotechnology".

Although you may not be able to capture the dynamic gains with a passive portfolio you can participate by finding those companies that will use materials science etc. to improve what they are already doing.
Think Kyocera or 3M, Siemens, GE, ABB et al.