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‘Death of the Cult of Equities’ Debate Explained: Bill Gross vs. Jeremy Siegel

Aug. 3, 2012
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PIMCO’s  Bill Gross has been sparring with Wharton’s Jeremy Siegel in what is being called the “death of the cult of equities” debate.  Gross claims, in a recent open letter to investors, that equities will have substantially diminished returns going forward.  In response, Siegel defends his trademark view that stocks are the right investment for the long term.  Both of these great financial minds have been well-respected industry experts for decades, making this public disagreement so noteworthy.  So what’s all the fuss about?  NerdWallet sorts through the facts.

Bill Gross’s argument


  • 100 year annual real returns
    • Stock market = 6.6% (called the “Siegel constant”)
    • Real GDP growth = 3.5%


  • Stockholders’ returns + Others’ returns = All returns (GDP growth)
    • If Stockholders’ returns = 6.6% and GDP growth 3.5%, “Others’ returns” must equal negative 3.1%
    • Those “others” received negative real returns over the past 100 years
      • Government:  Declining corporate tax rates
      • Labor: Declining real wages
      • Lenders:  Declining real returns
      • After 100 years of sacrifice, the “others” cannot afford to give up more


1.    Stock returns must fall to the GDP growth rate (historically 3.5%). 

“Others’” returns cannot continue to be negative.  Labor cannot afford to give up any more of their real wages.  Government cannot afford lower taxes.

2.    Spending will decline and slow GDP growth, further hindering stock returns.

Institutions that have assumed high stock returns will have to cut spending.  People will work longer to achieve the same standard of living without high stock returns.

3.    Inflation will be high.  Long-term bondholders will suffer.

The government will try to inflate their way out of the problem, but these nominal stock returns are not the same as real returns so it won’t work.  This inflation will hurt current long-term bondholders.

Gross’s conclusion that stocks will not earn a high return for “decades” has been very controversial.  Jeremy Siegel, in his famous book “Stocks for the Long Run,” claims that the stock market rate of return is relatively constant.  This gave rise to the concept of the “Siegel constant,” the 6.6% annualized real return expected in the stock market.  Gross claims in his piece that the Siegel constant is “a mutation likely never to be seen again.”  Siegel responded to this claim on CNBC with the following argument.

Jeremy Siegel’s argument


  • Gross is comparing the wrong stock market returns to GDP growth
    • Gross’s definition: Price Appreciation & Dividends
    • Siegel’s definition: Price Appreciation only
      • Dividends should be ignored when comparing the stock market returns to GDP growth because dividends are spent by the stockholder
      • Total Return (Price Appreciation + Dividends) is “almost always” greater than GDP growth


The past 100 years of 6.6% real returns on stocks were normal, not an anomaly, and can continue.

 Gross quickly dismissed Siegel’s response as not addressing his argument, claiming that Siegel may not have even read the original piece.

 So who is correct?  Let’s work through the numbers.

 Gross’s argument – An Illustration

  • A company is worth $100
  • The company grows by 3% over 1 year to a value of $103
  • The company pays a $3.10 dividend
  • The company cuts real wages by $2  (Real wages can be cut without cutting nominal pay by increasing wages less than inflation)
  • The company’s taxes owed decrease by $1.60 due to declining U.S. corporate tax rates
  • After these adjustments, the company is worth $103.50 ($103 – $3.10 + $2 + $1.60)
  • This cycle repeats every year
  • Total Annual Stock Return (6.6%) = Price Appreciation (3.5%) + Dividends (3.1%)
  • Price Appreciation (3.5%) > GDP Growth (3%)
  • All numbers are “real” (inflation-adjusted)

Gross’s view

This IS NOT sustainable because labor & government cannot give up 3.6% forever

Siegel’s view (implied by his limited comments)

This IS sustainable.  Even if labor & government cannot give up any more, stocks will not necessarily falter because GDP does not directly drive stock returns of individual companies.  The stockholder spends his 3.1% dividends (and possibly more), reinvesting in the economy, not “skimming” from it, as Gross claims.  Stock market price appreciation can “always” exceed GDP growth.

The Macroeconomic  Theory

The difference between the arguments lies in how directly GDP growth drives stock market returns.  If GDP growth directly and exclusively driving total stock market returns then Gross is correct and the day of reckoning is coming for stockholders.  If not, Siegel could be correct.

Macroeconomic theory suggests a loose tie between GDP growth and investment returns, but not the direct link that Gross’s argument depends upon.  There are many factors that contribute to GDP growth that may or may not impact stock returns.

GDP = Consumption + Investment + Government Spending + Net Exports

Further, GDP is essentially a measure of the amount of spending in an economy, without regard to how profitable those sales were.  Two economies with the same GDP could theoretically have very different stock market returns if one sells product at a huge profit while the other operated at a loss.  Additionally, not all business in the economy is done by publicly traded companies so the stock market only represents a subset of the market that the GDP metric covers.

So economic theory does not provide an airtight defense of Gross’s argument.  Nevertheless, Gross is a practitioner and there are many things that happen in the real world that economic theory does not perfectly capture.  So is it possible that GDP growth is linked to stock market returns empirically?

Gross’s claim:  Empirically tested

If Gross’s assertion that U.S. Total Stock Market Real Returns have captured approximately twice GDP growth (by “skimming” from workers and the government) is true, then market returns should go up approximately 2% for every 1% increase in GDP growth.  Using data from the past six decades, we find a positive correlation that is approximately in line with Gross’s claims.  However, the relationship is very weak and the predictive power of this relationship going forward is questionable.  In other words, Gross is likely correct (the positive 2 coefficient on the independent variable), but the data does not PROVE the relationship he cites really exists (low R-squared).

Siegel’s claim: Empirically tested

Siegel claims that we should be looking at Price Return, not Total Return, when comparing market returns to GDP.  He claims that over time real stock market price returns will “always” outpace GDP growth.  In other words, for every 1% increase in GDP growth, stock market price returns should be greater than 1%.  Empirically we find this to be true (positive coefficient), but again the relationship is weak and not necessarily predictive (low R-squared).


Gross and Siebel are both highly educated and experienced financial markets experts.  It is not surprising that no economic theory or empirical data declares one the winner.  It is likely the case that the truth falls between the two extremes.  A country without strong GDP growth over the long term will probably not have a thriving economy and stock market, as Gross suggests, but the correlation between the two is probably not direct and immediate so there is room for stockholders to slightly outperform GDP growth, as Siegel suggests.

Vanguard Group founder Jack Bogle is probably closer to the truth than either Gross or Siegel.  Bogle diplomatically acknowledges both men’s positions, but sides slightly with Gross, citing a more moderate 5% as his personal long-term expectation of lower stock market returns.  However, he points out that the more important issue than who is correct is what needs to be done to adjust to lower returns going forward.  “That’s a national problem.  It’s state and local governments, its corporation and there’s no defense of that 8 percent and Bill is right here.”