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Gross: Cult of Equities is Dying

"Equities are still alive, but the cult of equities is dying."  - Bill Gross, Founder and Co-Chief Investment Officer of PIMCO, manager of the world’s largest bond fund with AUM of $270B, make a “high-profile” commentary in his August commentary.

Gross differentiated between stocks as an asset class, and the unrealistic expectations some investors have about their potential for returns (double-digits returns in equities) – ‘cult’.  To Gross, “Equities have reached a dead end in terms of significant appreciation” and that a “30, 40, 50-year old cult” of equities returning double-digits was nearing and end.  He believed that stocks are still likely to return more than most other asset classes, they would occupy a less cherished and lucrative place in investors’ portfolios.  He said investors may want to search for investments other than in stocks and bonds, such as land or other assets.

“Cult of equity” – espoused by Wharton Professor Jeremy Siegel and his disciples who believe, with the exception of brief bear markets, stocks are the most consistent game in town.

With reference to Chart 1, illustrating the stocks performance over a century’s time.  This long-term history of inflation adjusted returns from stocks demonstrates a persistent but recently fading 6.6% real return ( known as the Siegel constant) since 1912.  What it meant is that, if one were to born in 2012 and lived to 100, they would have turned what on the graph appears to be a $1 investment into more than $500 (inflation adjusted) over the interim.  This is the ‘classic example ’ of ‘letting money do the hard work

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From Gross’s perspective, the return of stocks above the rate of economic growth as measured by gross domestic product cannot be sustained.  Why?

"The 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes - a Ponzi scheme," he says. "If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year.

"If an economy's GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, labourers and government)?"

The dawn of what the firm has coined the "New Normal" - a prolonged slow-growth period - will thwart gains for both stocks and bonds, he says.

"Together then, a presumed 2% return for bonds and an historically low percentage nominal return for stocks - call it 4%, when combined in a diversified portfolio produce a nominal return of 3% and an expected inflation adjusted return near zero," he says. "The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned."

Reference:

  1. CNBC, Jeff Cox, 20120731, “Bill Gross is Latest to Join ‘Stocks Are Dead’ Club”
  2. CNBC, 20120816, “The ‘Worship’ of Stocks is Dead:  Bill Gross”
  3. PIMCO, 201208, “Investment Outlook: Cult Figures”