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.