Bill Gross just published an interesting article proclaiming that the "cult of equity" is dying.
I agree with Gross on a few selected points, but mostly, I disagree. I'll break down his individual arguments below with my responses.
1: Long Bonds Bad - We Agree
Gross: 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.
Move along people, nothing to see here. This one's fairly obvious; I agree with Gross. I've been saying for a while now that low Treasury yields are unsustainable, and anyone purchasing long bond funds like (TLT) is throwing money down the drain.
2: Stocks May Model Japan - We Disagree
then the economy's wheels start spinning like a two-wheel-drive sedan on a sandy beach. Instead of thrusting forward, spending patterns flatline or reverse; instead of thriving, a growing number of households and corporations experience a haircut of wealth and/or default; instead of returning to old norms, economies begin to resemble the lost decades of Japan.
I'm really not sure what Gross was smoking when he wrote this one, because the argument falls flat on his face when you scroll down a few paragraphs. Japan has been in a deflationary environment for a long time now. So to compare the U.S. to Japan, you'd have to assume that the U.S. is going to follow in those deflationary footsteps. And what does Gross think about the coming inflation/deflation?
The primary magic potion that policymakers have always applied in such a predicament is to inflate their way out of the corner. 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%! [...] 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.
So Gross essentially disproves his own point. Our stock market will not model Japan's.
3: Portfolios Will Return 0% - We Strongly Disagree
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.
I'm really not sure what happened to Gross, but he fell off the train on this one. There are plenty of macro drivers that will ensure real growth over the coming years. These include:
Population growth is a natural economic driver. Why? Well, across the board, more people means more sales opportunities. Apple (AAPL) can't sell iPhones to people that don't exist.
But the driver that's even bigger is:
- the rising global middle class
Literally billions of people are going to be coming out of poverty over the course of our lifetimes. What does this mean? Again, economic growth. That's a billion more people who could be using toilet paper made by Kimberly-Clark (KMB), shampoo made by Johnson & Johnson (JNJ), and drinking Coca-Cola (KO). These items are seen as "staples" by the West, but are in fact "luxuries" to the poor in 3rd world countries. The same argument extends to cars made by Ford (F), toys made by Hasbro (HAS), and the wares of just about every other publicly traded company out there.
There are many other drivers as well, like productivity gains. Think more productivity gains are impossible? Think again. Quantum computers could make today's supercomputers look as slow as the 166 MHz Windows 98 machine that's collecting dust in my garage.
The point is, can we predict the exact returns of the stock market? No. Can we assume they'll be greater than zero in real (inflation-indexed) terms? You bet. Gross fell off the train on this one.
Bonus Round: Stocks Perform Poorly Under Inflation - We Disagree
Gross: [...] Similarly for stocks because they fare poorly as well in inflationary periods.
What? No. According to an inflation calculator I found on Google, $1 in 1912 dollars is worth $23.81 in today's dollars. That's pretty inflationary, yet by Bill's own admission, stocks returned 6.6% on a real (inflation-adjusted) basis. Stocks keep up with inflation. As Donald Yacktman puts it, Coca-Cola is a better inflation hedge than gold (GLD). The price of a can of Coke obviously keeps up with inflation, and therefore, so does the price of Coca-Cola stock.
I'm a devotee of the cult of equity. This has led to more than one person calling me a "sheeple." But I'm okay with that. Equities are a great equalizer. For many people, it's barely feasible to own one piece of real estate, much less more than one - yet index REIT funds like Vanguard REIT Index ETF (VNQ) allow investors with small amounts of capital to capture rent payments and long-term real estate returns. Similarly, even if you don't have the capital to own a store, you can own a tiny share of thousands of stores by purchasing stock in Walmart (WMT). Any investor with $140 can buy a small slice of 500 major U.S. companies by purchasing one share in the SPDR S&P 500 ETF (SPY). Stocks rock. Publicly-traded stocks allow the common man to grow his wealth over time.
In the current environment, stocks are the best long-term option for forming the core of a portfolio. By Bill's own admission, inflation may be high, which kills cash and bonds. Stocks are the only thing left.
Stocks are always risky, and it's entirely possible that they won't provide the same rate of return as they did during the heyday of the '80s and '90s. But to predict that they will barely return more than inflation is a little ludicrous.
The world hasn't ended yet.