In his recent interview with Excess Returns, Rob Arnott of Research Affiliates presented compelling research that challenges conventional economic wisdom while providing valuable perspectives into current market conditions.
“Stimulus always involves picking winners and losers and therefore is always likely to be at least moderately misguided,” Arnott says, dismantling the myth that government spending reliably boosts growth. His team crunched 80 years of data and found a relentless pattern: “The countries that spent more grew slower.” This isn’t just cross-country analysis—it holds true over time within nations too. “For about 80% of countries, when they boost spending, growth decelerates.” The exception? Switzerland. “Be that as it may,” he deadpans.
Arnott reserves special criticism for modern Keynesian dogma. “Keynes himself would be appalled at some of the things that are called Keynesian these days.” The original idea was simple: save in good times, spend in crises. Instead, we’ve created a monster. “We’ve got $36 trillion in national debt… The government owes 700% of its annual tax revenues. How would you feel if you had debt seven times your annual income?”
Where’s the sweet spot for government spending? Arnott’s research suggests 15-30% of GDP. Below that, you risk chaos (“Somalia has very little spending—it does not have good robust growth”). Above it? You get Japan—a cautionary tale where debt crowds out private dynamism. “Any available cash gets hoovered up by government… You don’t get people saying ‘I’d like to borrow to fund a new initiative.’”
On markets, the U.S. large-cap outlook? “3.9% expected return over the next 10 years… less than you get from bonds.” Growth stocks are even worse: “Only 2.5% return—basically zero in real terms.” His advice? Look where mean reversion favors the bold. “The spread between large cap and small cap is the biggest in history.”
“Nobody likes to buy a bargain because bargains got there by inflicting pain.” But with the Magnificent 7 now at 30% of the S&P 500—”we’ve never been that high ever before in history”—the math is clear. Either these giants deliver “stupendous growth” to justify valuations, or gravity wins. Given Arnott’s track record, investors might want to bet on gravity.
Arnott’s research ultimately reveals a market at crossroads. ‘This is an opportunity-rich environment,’ he concludes, emphasizing that the most promising prospects lie outside today’s crowded trades. His analysis suggests investors may need to look beyond popular benchmarks to find true value.
You can watch the entire interview here:
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