The continued viability of the 4% rule in the US in the 21st century

[jacob]

To bring the discussion back on topic, what I was interested in was the likelihood that going forward, PE ratios will truly decline because a meaningful income distribution from capital to labor is expected.

For that reason, it's pretty much zero. It sounds good but it doesn't math out in terms of the monetary magnitudes involved. (And this is why you should not get your economic news from bubbles.)

If labor1 is replaced with labor2 at a higher salary with no increase in productivity (no direct reason why productivity would go up simply from hiring other people), earnings go down, because earnings = revenue - expenses, and salaries are part of expenses.

Another way of seeing it is that "typically" for a given business, the rule of thumb is that 1/3 of revenue goes to owners, 1/3 to workers, and 1/3 back to keeping it going. (This is correct within an order of magnitude.) The money that goes to owners is called "earnings" and you're directly asking to change the earnings/salary ratio here.

Since Earnings are the denominator in P/E, then decreasing earnings increases P/E insofar the market is willing to tolerate that. If not, then P follows E downwards.

This basically leaves second-order effects. Ford famously paid a higher wage to his employees so that they could afford to buy the cars they were making. This works well in those old-fashioned company towns which were effectively closed systems. Money had to circulate. If labor2 now earns more also spends more to boost revenue, then even if the earnings/salary ratio changes, earnings will get lifted on an absolute scale. The pie may be sliced differently but overall, it's bigger. Again, this is unlikely because goods and services can simply be exported elsewhere. It is no longer a closed system.

Overall, the main problem with this whole line of thinking is the lack of math and proportion. We're talking about replacing something like 1% of the labor force and the unskilled and low paid (<$8-15/hr) at that possibly getting a slightly higher salary. As a slice of the overall economy it's immaterial even though of course for an unemployed HS dropout that now lands a $20/hr job at a meatpacking factory or gets a job as a roofer or an apple picker, it would make a big personal difference.

If you want to understand BIG impacts on the financial markets, you can safely ignore the poor (not trading stocks) and the rich (also not trading because buying and holding for generations). Focus on what the middle class is doing (via their pension funds!) and where their money goes in terms of spending and saving.

[sky]

In the ag sector, I would expect that capital would move into mechanization of agricultural processes. This is a continuation of ongoing mechanization of agriculture. I don't see much that would change PE ratios.

[zbigi]

More broadly, I don't think P/E ratios depend on how a particular asset class is doing, but on the balance of general investment opportunities available vs amount of capital looking to be deployed into those opportunities. Doesn't matter if it's stocks, bonds, real estate or anything else, all asset classes move in concert here.

[delay]

US exports is about 11% of GDP while US imports is about 14% of GDP which makes for a net trade deficit of 3% relative to GDP but ~30% in terms of trade in vs trade out.

Thanks, that puts things in perspective! I didn't know US imports were just 14% of GDP.

If that flood reverses, then Americans get to enjoy 103%-3%=100% of the stuff they enjoyed last year. What's the problem with that?

As you've shown there's a good deal of knowledge that I'm not aware of. To try to answer, it seems to me Americans won't be happy with having less stuff, and America is the world's Great Power. People around the world want to be friends with America and are willing to pay for that. For example, the Netherlands purchases US defense equipment partly because we want to be on Team USA. So the same money that represents US exports also represents goodwill or tribute payments.

So let's say the trade balance shifts, the US people enjoy less stuff, and become unhappy. They strong-arm the rest of the world into importing more US defense products. The trade balance shifts back again.

It seems to me that if you package tribute payments as bad deals, this can go on forever. For the 4% rule it would be important not to enter into the same deals that the tributary nations do.

[chenda]

For example, the Netherlands purchases US defense equipment partly because we want to be on Team USA. So the same money that represents US exports also represents goodwill or tribute payments.

So let's say the trade balance shifts, the US people enjoy less stuff, and become unhappy. They strong-arm the rest of the world into importing more US defense products. The trade balance shifts back again.

Or they rearm by purchasing inhouse manufactured defence products, both to stimulate their own defence industries and reduce reliance on the foreign supplier playing nice. For example the EUs €150 billion rearmament fund has to be majority used for EU and CANZUK suppliers (not to start a political discussion, just an example)

[7Wannabe5]

The defense industry in the U.S. only accounts for around 4% GDP. The finance industry (inclusive of real estate transactions) in the U.S. accounts for around 20% of GDP. So, I would assume any frictionless model to be flawed. Also, in 1996 there were over 8000 publicly traded companies in the U.S. and now there are less than 4000, even though the total amount of capital now invested is 7X larger and the economy is 3X larger. And it is also the case that the largest shareholder in most of these companies is some combination of Vanguard, Blackrock, or State Street Index Funds. A secondary effect of index funds is to reduce competition within a given industry.

[Western Red Cedar]

A secondary effect of index funds is to reduce competition within a given industry.

Can you elaborate on this? Could this be a case of correlation rather than causation? It seems to me like the main culprit here is a lack of sufficient anti-trust regulations in the US and changes to the business strategies of large corporations over the past couple decades. See Adobe's attempted acquisition of Figma as a recent example.

[7Wannabe5]

@WesternRedCedar:

I agree that it is unlikely to be the main culprit. OTOH, you have to wonder about motivational profile if/when a single index fund is the majority stock holder of all the largest firms in a given industry. Anyways, I was just trying to point out changes in the field that seem somewhat significant in terms of the present towards the future not being so much like the past to which 4% rule may apply. Might be more notable than meaningful. Dunno.

[IlliniDave]

The most recent numbers I've seen is that passively managed funds in the aggregate hold about 20% of the SP500. So we're still a long way from any single management entity actually having control of things. And I don't think the fund managers habitually vote in an anti-competitive way. They tend to follow board recommendations (some more than others). I suspect that's not much different than how the other 80% of shareholders vote, if they even bother.

[7Wannabe5]

@IlliniDave:

Founded in 1975 by John Bogle, The Vanguard Group pioneered passive investing, an innovative way to reduce the cost of the investment process and simplify it for everyday Americans. Since then, passive investing, led by index funds and exchange-traded funds, has exploded. According to Statista, passively managed index funds accounted for 19% of the total assets investment companies managed in the United States in 2010. As of 2023, that number had skyrocketed to 48%.

But even Bogle began to wonder about the unintended consequences of too much passive investing. Shortly before he passed away in 2019, he predicted it wouldn’t be long until index funds would own half of all U.S. stock, which he didn’t consider a good thing: “I do not believe that such concentration would serve the national interest.”

https://merage.uci.edu/news/2024/10/The ... rkets.html


IOW, this is a situation that has changed significantly within the time frame of this forum's existence. See also the fact that 50% of consumer spending in the U.S. is now done by the top 10% income (over $250,000 year) bracket.

When consumers gain wealth, their spending typically increases. They often feel more confident in their personal financial situation, leading them to spend more of their income and put less into savings. This can occur when the market has helped them achieve their savings goals – for example, because the value of their stock and bond holdings has increased – allowing them to purchase more goods and services today while maintaining confidence in their future financial situation.

https://usa.visa.com/partner-with-us/vi ... nding.html

IOW, luxury spending accounts for almost all excess emissions contributing to climate change.