Yes, Bill Gross is right. The "Cult of Equity" is dead, and the stock market has been functioning like a well run Ponzi scheme for nearly two decades. But Mr. Gross is specifically speaking of the cult of equity and the Ponzi scheme that exists here in the United States. The historically superior returns in U.S. equities, taking the market as a whole, is over. The best days are far behind us. Great returns in equities will still occur, but investors will need to look overseas for them, specifically in the emerging and frontier markets.
But let's consider the cause of those great returns and when and why the peak in those returns occurred here in the U.S. The returns were achieved during the 20th century. The century, you may recall, where the years begin with the number "19." Those returns first peaked at the end of the tech bubble in March of 2000, less than three months into the new century.
Following the tech collapse, U.S. stocks benefited greatly from the real estate bubble, which propelled the S&P 500 to similar heights between 2002 and 2007. But that bubble popped as well. Just after the S&P peaked in October 2007, the stock market embarked on a too familiar decline for the second time in less than a decade.
Twelve years into the new century and we find ourselves once again trying to get back to those previous highs. And once again, as we creep ever closer, the rallying cries of both bulls and bears are reminiscent of those previous stock market rallies, rabidly opposing each other like the hyper-polarizing political miscreants on cable television "news" programs.
Please consider this not quite rhetorical question: What will be the catalyst for equities in the U.S. to meet and exceed the previous peaks? Don't know? Me neither. And therein lies the problem.
We can recount through our country's young history the cause and effect of many of the highs and lows experienced over decades of stock market advancement. Generally speaking, the growth of the U.S. stock market was the result of a young country with dominant military and economic influence reaping the reward of rapidly becoming the king of the hill. Them days is over.
So Mr. Gross is right. The heyday of U.S. stock market growth has peaked. Were it not for the tech bubble and the real estate bubble, we probably would not have reached those previous heights in the first place. We'd also probably have a more pragmatic outlook for future growth.
Since the bottom in March of 2009, the stock market has climbed perpetually higher based upon the expectation that it would and by the aggressive actions of the Federal Reserve. I call that a self-fulfilling prophecy. Hope, No Change and Monetary Policy. On almost all counts, the economy is still in the crapper. And yet we are almost at levels commensurate with those two previous peaks, periods where the unemployment rate was half of what it is today.
So without a genuine catalyst to go higher, we are probably near the peak once again. The most likely scenario is the continuation of a 1970s style stock market -- that 1966 - 1982 period where stocks ended flat after many years of substantial peaks and valleys. And there does exist tremendous downside risk today.
The following chart show the S&P 500 diagrammed in the manner I have been tracking and writing about for several years now. There are two technical observations of merit. One is what I have referred to as the "Triple Peak." That is the expectation that the current rally will peak at or just below the levels of March 2000 and October 2007. As stated earlier in this article, those two grand ascensions can be attributed to tech stocks and real estate. The one we are in now is just monetary policy and optimism.
(click images to enlarge)
The second technical observation is what can be viewed as a head-and-shoulders formation. The peak at October 2007 is a bit higher than March 2000. If the top of the current rally ends below the October 2007 point, we would have a head-and-shoulders, which is bearish, of course. The downside from that point is very far.
My suspicion is that without some really great economic improvement, a sequence of stellar earnings seasons and/or additional Fed activity, we are probable very near the top. Whether if manifests as a triple peak or a head-and-shoulders is irrelevant. Take the tech bubble, the real estate bubble and the monetary policy bubble out of the equation, and we have a stock market that probably doesn't belong where it is.
So the question remains: Now that we got back to to this point, what will be the catalyst to move higher?
I have also compared the U.S. to Microsoft (MSFT). Once the must-own equity, it has long been optional. The U.S., like Microsoft, went through a long period of exceptional growth. Both were standouts and absolute leaders of the pack. But as with most things, outsized growth and dominance cannot last forever. Microsoft grew and eventually reached the threshold where it could no longer do enough to materially advance the company -- the point of diminishing returns had been exceeded.
For those investors who rely on indexing or may be married to the idea of U.S. exceptionalism, especially as it relates to investing, it's probably a good time to review your holdings. The SPDR S&P 500 (SPY) has averaged 5.23% per year over the last decade. The index that the iShares MSCI Emerging Markets Index Fund (EEM) is based upon has averaged 14.08% over the same period (the ETF has not been around for 10 years yet). Do I expect the same results in the future? Yes and no. I do expect emerging markets to continue to outperform. But given the slowdown in some of the emerging market countries -- like China -- the better returns are likely to come from emerging countries not quite as far down the developmental road.
The frontier markets are the ones that will likely outperform them all. Jim O'Neill, chairman of Goldman Sachs Asset Management and the guy who came up with the BRIC acronym, has identified four countries he thinks will lead the pack: Mexico, Indonesia, South Korea and Turkey -- the MIST countries. These and others will be the countries that stock or fund investors must look to for above average returns.
Bottom line: I suggest investors temper their expectations for U.S. stock market performance and begin to diversify into the frontier markets if they hope to earn results like we once could in the U.S.