The bell is tolling for equities, Bill Gross believes, and he says historical evidence has given an inflated view of their potential for returns and skewed investors’ outlook.
In his latest market commentary, the world’s biggest bond manager who runs the $260 billion PIMCO Total Return Bond fund, says equities' long-term inflation-adjusted returns show a fading return rate and governments could soon turn to inflationary measures to boost returns.
‘The cult of equity is dying,’ said Gross.
‘Several generations were weaned and in fact grew wealthier believing that pieces of paper representing “shares” of future profits were something more than a conditional IOU that came with risk.’
But times have changed, said Gross, saying Jeremy Siegel's book ‘Stocks for The Long Run’ published in the 1990's encouraged investors to invest in equities at the wrong time.
‘Now in 2012, however, an investor can periodically compare the return of stocks for the past 10, 20 and 30 years, and find that long-term Treasury bonds have been the higher returning and obviously “safer” investment than a diversified portfolio of equities. In turn it would show that higher risk is usually, but not always, rewarded with excess return.’
‘This long-term history of inflation adjusted returns from stocks shows a persistent but recently fading 6.6% real return (known as the Siegel constant) since 1912 that Generations X and Y perhaps should study more closely.’
Siegel constant a 'historical freak'
The outspoken bond manager said common sense would argue that appropriately priced stocks should return more than bonds.
‘Yet despite the past 30-year history of stock and bond returns that belie the really long term, it is not the future win/place perfect order of finish that I quarrel with, but its 6.6% “constant” real return assumption and the huge historical advantage that stocks presumably command.’
'The legitimate question that market analysts, government forecasters and pension consultants should answer is how that 6.6% real return can possibly be duplicated in the future given today’s initial conditions which historically have never been more favorable for corporate profits.'
His criticism of long-term return outlooks was not only limited to equities as his own sector came under fire.
‘With long Treasuries currently yielding 2.55%, it is even more of a stretch to assume that long-term bonds – and the bond market – will replicate the performance of decades past,’ he said.
‘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.’
‘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.’
The cult of inflation
Gross said as returns hit new lows and growth struggles, global policymakers may attempt to inflate their way out of trouble.
‘The easiest way to produce 7–8% yields for bonds over the next 30 years is to inflate them as quickly as possible to 7–8%! Woe to the holder of long-term bonds in the process! Similarly for stocks because they fare poorly as well in inflationary periods.’
'Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades.'
‘The cult of equity may be dying, but the cult of inflation may only have just begun.’
Here you can read the full version of Bill Gross' latest market update.