Article by Investment U
On August 13, 1979, BusinessWeek famously ran a cover article entitled The Death of Equities, arguing that investors should shun stocks due to concerns about the long-term health of the U.S economy.
The timing was less than auspicious. Within months, the stock market began the longest and most powerful bull market in U.S. history.
Earlier this month, Bill Gross, the co-founder and co-chief investment officer of Pacific Investment Co. (better known as PIMCO), argued in his widely-read blog that the “cult of equity is dying.”
Investors aren’t just buying his argument. They seem to have predicted it. How else do you explain the fact that they have yanked some $200 billion out of equity funds since January 2011.
These investors are making a huge mistake, especially if they’re plowing the proceeds into bond funds like Gross’s. Here’s why…
A Premature Autopsy…
Gross labels the high returns on U.S. stocks since 1912 a “historical freak,” one that won’t be duplicated soon. But grand predictions like these should always be taken with a grain of salt. Besides, there are a number of problems with his analysis.
The first is that Gross seems to be unaware that foreign markets have generated ultra-long-term returns very similar to those in the United States. (For a thorough historical analysis, read Jeremy Siegel’s Stocks for the Long Run, now in its fourth edition.)
The second problem with Gross’s premature autopsy is his insistence that corporate earnings cannot grow faster than the overall economy. Yet history shows no direct correlation between GDP growth and corporate earnings over the long haul. Although there is a strong correlation – in fact a causality – between corporate earnings growth and stock market performance. And please note we’re currently in a period of record corporate profits, record profit margins and record corporate cash on hand.
Pundits and bloggers have been quick to jump on Gross’s comments over the last couple weeks, some agreeing, others disagreeing.
A Great Contrarian Indicator
One of the voices you should listen to is Burton Malkiel, author of the investment classic A Random Walk Down Wall Street. In an op-ed piece in The Wall Street Journal this week he wrote, “Equities are more attractive relative to bonds than at any other time in history. Locking retirement funds into ‘safe’ 1.5%-yielding Treasury securities is likely to be a sure loser after inflation… The only hope – both for individuals and for institutions running retirement portfolios – is to increase, not decrease, the share of the portfolio devoted to equities.”
As in the old BusinessWeek cover, high-profile predictions like Gross’s are often great contrary indicators. This one may well precede another delightful rise in equities.
It won’t be an easy climb, of course. Stocks will always be a volatile asset, one that engenders queasy stomachs and sleepless nights. That’s simply the price you pay for earning returns much higher than cash or bonds.
This year is proving to be no exception. The S&P 500 is currently up 12% year-to-date and, with dividends reinvested, has more than doubled over the last three and a half years. If this is “the new normal,” sign me up.
In addition, when bonds start to sell off – as they will eventually – investors will realize they have made a terrible bargain. Hoping to accept low but positive returns in exchange for peace of mind, they will end up with neither.
If PIMCO didn’t have more than $1.5 trillion in fixed-income assets under management, perhaps that is what Gross would be warning investors about.
Good Investing,
Alex
Article by Investment U
