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Good morning. Good morning. My name is Matt Sauer, and I'm from Durham, North Carolina. In a 1977 Fortune magazine article titled "How Inflation Cheats Stock Investors," you argued that corporate earnings generally behave like bond coupons and are therefore negatively affected by high inflation. Because of the high inflation at the time, you assumed a world where the 12% return on corporate capital shrank to 7% after taxes and in real terms fell to 0%.
You have been expressing pessimism about the outlook for stocks for several years now. Much of which, we assume, is due to the extremely high initial estimates . If inflation was clearly bad for investors in 1977, isn't its relative absence in today's economy at least a plus for stockholders? Is there also a component of expectations of future inflation in your warnings that investors are likely to be disappointed with stock performance?
Well, I would say there is no doubt that the lack of inflation is a plus for owners. That is, the real income that you will receive, in my opinion, from owning an American business, if it is purchased at similar prices, will be higher if we have prolonged periods of low or near-zero inflation than if we had prolonged periods of high inflation.
I don't think there is any doubt here, as that article explained how you are taxed on nominal profits and fictitious profits in real terms. So, your question about which period is better for investors—a period of low inflation for any length of time is better for investors. And the problem, as you also pointed out, was the starting point for projecting modest returns for equity investors.
The returns weren't necessarily that modest, I think they were just modest compared to what people had come to expect during that long bull market from 1982 to 1999. There were polls conducted by Gallup together, I think, with Paine Webber at the time. Now they have moved to UBS Warburg, which showed people's expectations about the stock market.
And the returns that people were counting on were 14% or 15%, as I remember. And they thought they would get 14 or 15 percent in a low inflation environment. Well, you know, those were dreams. And in a low inflation environment, there's nothing wrong with getting, you know, 6 or 7%. This is probably the best thing that could happen, because in a low inflation environment, how much will GDP grow?
Well, GDP, you know, if you have 2% inflation and even 3% real growth, then we're talking about 5% GDP growth in nominal terms. If GDP grows at this rate, over time corporate profits will also grow at about the same rate. And if corporate profits grow at 5% per year, the value of those profits, the capitalized value, is likely to grow at about the same rate in the long run from some normal starting point.
Add to that dividends and you get 6 or 7% before operating expenses. Investors bear many operating costs. They don't have to do it , but they do. And this often amounts to 1.5–2 % of their investment. So, the math is not bad. It's just bad for those people who are used to or expected very high profits, looking back at the situation in 1998 or 1999 .
Charlie? My overall attitude is a little more pessimistic than Warren's. You heard it, friends. This is not the end of the world. I mean, basically, if the people who own American businesses get 5-6% of the pie—a $10 trillion economy now, a $20 trillion one day . But if we get 5 or 6% of the pie, those of us who have invested our capital in producing goods and services for American businesses, for American consumers, for the American population.
Whether this is, you know, I don't know, whether this is exactly what someone who designed this universe would come up with. But it does n't seem crazy to me on either side. You know, I think that's a lot of goods and services that go to the people who provided the capital. But you have over 100 million people in the workforce working to create it for you , using your capital, and that provides what I would consider a pretty good real return with low inflation.
If you face high inflation, which I wrote about back in '77 , you can easily get very low real returns for investors, maybe even negative. That is, inflation can deceive the equity investor, as I wrote then, and I spent 7,000 words explaining why. I'd be happy to send you a copy of that article if anyone is still interested, but inflation is the only thing that can turn investors' aggregate returns into negative territory over a long period of time.
And this is the enemy of the investor. Charlie, does this give you any additional thoughts? I don't think you'll get perfect help on these issues from professional economists either. They have certain standard formulas. To an economist, when manufacturing jobs go to China, it's just a kind of productivity increase.
And if you ask one, say, let's say all the manufacturing jobs in America went to China, wouldn't that be too much of an efficiency gain? And their answer would be "no." And people are actually paid to think this way at top universities. If, of course, what would help get this point across is if all economics teaching were exported to China, then a new understanding would emerge . And number six, Jack Hurst
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