Are Stocks And Bonds Dead?

by: Lowell Herr

The November 26th issue of Time magazine carries an article by Rana Foroohar focusing on Bill Gross and Mohamed El-Erian, PIMCO executives, who are frequently quoted about the market outlook and reasons why they are both so pessimistic. Gross and El-Erian don't differ all that much from Grantham's On The Road To Zero Growth projections.

Quoting from the Time article, "Gross recently stunned the markets by calling equities a Ponzi scheme and warning investors they will never see 6% real returns again and would be lucky to get 3%. Gross and El-Erian believe there will ultimately be a price to pay for the Fed's money infusion in the form of return eroding inflation and other economic distortions. When that happens, real growth (already sluggish) will stagnate further, borrowing cost will skyrocket, stocks will swoon, real estate will struggle and consumers will hunker down."

Later in the article are statements one does not hear discussed among at least a large minority of the voting public. "Growth killing inequality is rising. And the rich aren't paying enough taxes, especially in an era when lower returns will change retirement plans for millions. Without major policy changes, Gross and El-Erian believe, the U.S. won't have the mojo to grow beyond a 2% economy anytime soon. In other words, some of the world's best surfers are saying, Get out of the water."

The 2% growth rate may become the new normal, not for a few years but for decades. This may be the 1970s all over again. Here are a few more select quotes from the article.

"A lot of people aren't being paid enough to spend." That is exactly my point. Let me digress and tell a short story of my two granddaughters. When they were quite small, around 4 and 2 years of age, we had two big appliance boxes in the basement and a wide array of toys. The boxes were set up to use as "houses" and the girls were to share the toys. The older began to stuff toys in her box to the point where she was no longer able to get inside the box herself. The younger child ended up with nearly zero toys. This is analogous to a small percentage of society capturing all the wealth for themselves leaving the vast majority with little to spend on goods produced by companies run and directed by the very wealthy who are trying to sell those goods.

"The new normal will simply continue to be so disruptive in the short term, say the oracles at PIMCO, that wealth redistribution via tax reform is a must for creating a society that's socially cohesive enough to weather several more years of slow growth."

"There should be tax reform where the wealthy pay more and corporations pay more but we end up with a more efficient system," Gross says.

Blue chip stocks have become the new bond market, but that could also change. Investors are seeking safety in high yield quality stocks as they are considered less risky. Not so says Seth Masters, chief investment officer with AllianceBernstein. Masters cites data showing high-yielding stocks are currently trading at a 50 percent premium to their historical averages. That is not what one calls - low risk. Holders of high yielding stocks could be in for a shock. Where does one go for value?

Masters claims that "Cheap stocks are very, very cheap today, relative to any time in long-term history." This implies we need to continue to skew our portfolios toward value. If you are stock picking, find the highest quality stocks with the lowest price/book ratio. Since we use ETFs, this means we will move toward VTV, VOE, and VBR. Other options are IWN, IVE, IJJ, and IJS.

Grantham's projections are even more dismal than the PIMCO executives. And he projects gloom and doom out as far as 2050. His article is downright depressing. What are some key reasons?

  1. Declining education. An example of ignorance is front and center in our legislative branch of the federal government. Consider a political party that places creationists in leadership positions of our scientific committees. To say education is declining is an understatement. The Dunning-Kruger Effect is at work.
  2. Income inequality. Here we have that topic crop up again. Grantham is in agreement with Gross and El-Erian. If the total society is not benefiting from the GDP of the nation, the GDP will slow. As a country, we have been aggressively working on wealth inequality since 1980.
  3. Debt overhang continues to be a major problem. Remember 2001 when the leaders of the U.S. were worried about paying off the national debt too soon. Instead of paying down the debt "the solution" was to cut taxes, start two unfunded wars, and blow a larger hold in the deficit with a reckless unfunded prescription drug plan. In a few short years the surplus was wiped out and a massive debt expanded. Now we have a major problem that needs attention and a large percentage of congress have signed a no-tax pledge with Grover Norquist, an unelected tax zealot. These are going to be tough times that will require some skilled tacking.

One thing facing young workers is that they will need to save more than the prior generation as the stock market has a much lower probability of performing as well as it did during the last half of the 20th century.