The Choice Is Clear, Despite What Bill Gross Saya

 |  Includes: MO, MRK, PG
by: Stocks-Options

On Wednesday August 1st, Gross said "The cult of equity is dying ... Investors' impressions of 'stocks for the long run' or any run have mellowed as well." His phrasing of "stocks for the long run" is the title of a well-known book by Jeremy Siegel.

Siegel is a Professor of Finance at the Wharton School and has written books emphasizing stocks. Bill Gross manages the $252 billion PIMCO Total Return Fund.

To drive his point home, Gross likens historical stock market returns to a "Ponzi scheme." Those are loaded words, deliberately used to make his point.

However, Siegel is on the right side of this argument because history is on his side. This time is NOT different.

Siegel emphasizes buying quality stocks that pay dividends and then reinvesting the dividends. This means that at lower prices, you will purchase more shares. It's like dollar-cost averaging. And it has worked for stocks like Merck (NYSE:MRK), Procter & Gamble (NYSE:PG), and Altria (NYSE:MO) just to pick three of many.

A 50 year chart of the S&P 500 or a one-hundred year chart of the Dow Jones Industrials make the point that over the long run, stocks go up. I know the components of the averages change regularly, but stocks have provided a greater return than bonds over time. Even over the last 12 years, a time of great volatility, stocks ended up about where they started. The ride has been quite bumpy but the trend was not down. And dividend reinvestment in quality companies would have produced quality results.

In addition, to make money in long-term bonds, you've got to believe the current interest rate will drop even further. That's a stretch.

But can we predict the stock market future from the past? Well, nothing is certain, but the three stocks above have steadily increased their dividends for at least 20 years (though in Merck's case, not every year.) Procter & Gamble and Altria have increased dividends yearly for over 40 years. These companies aren't going to disappear. And there are many others with familiar names that could be mentioned.

Just think of the many market swoons that occurred since 1972 - the Recession of 1973-74, the crash of 1987 where the market dropped 22 percent in one day, the two year drop in the S&P of 45 percent from 2000-2002, and the drop of 56 percent from 2007-2009. Many of us thought the financial world was going to end. Through it all, two of those stocks kept raising their dividends yearly. Reinvestment of dividends bought more shares at lower prices. And there are many others that have raised their dividends for over 25 years, in all sorts of stock market environments. See David Fish' list here.

The argument for bonds, of course, isn't going away. And maybe a portfolio should have both. Investors have recently pulled billions out of stock-based mutual funds and put them into high yield bond funds. Gross says that economic growth has outpaced stock market returns for a long time, but it can't do so forever. He says stock market returns like Siegel emphasizes are "an historical freak, a mutation likely never to be seen again as far as we mortals are concerned." In other words, this time IS different.

I don't think so.

As Siegel said on June 4th, "This is the first time in 60 years that dividend yields on the market exceed long-term interest rates. It's the first time in 60 years when you don't need gains in stocks to have a higher return than gains in bonds."

The current yield on the S&P 500 is about 2.0 percent and the 10-year Treasury yields about 1.5 percent. And many quality stocks yield more than 3 percent. Even buying an index fund mirroring the S&P 500 and reinvesting the distributions would work. But we can do far better by picking our own quality stocks.

We ignore dividend-paying stocks at our peril, no matter what we might hear.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.