- Articles - 2012 Blog - Bill Gross Death of Equities "The Cult of Equity is Dying" Article
                Windsurfing at Palo Alto in SF Bay in May 2009 PIMCO's Bill Gross on the Death of Equities
Implications of  Bill Gross article and what it means going forward
                Windsurfing at Coyote Point November 2009
Bill Gross calls for another "death of equities" by writing in his monthly "Investment Outlook" that "The Cult of Equity is Dying."

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August 1, 2012:  In this month's "Investment Outlook" article, Bill Gross, the founder and co-chief investment officer of the world's largest bond fund wrote "The cult of equity is dying."  In the article Gross explain why he thinks stocks are not really for the long run, a play on the book by Jeremy Siegel, Stocks for the Long Run.  Note that Gross still expects equities to provide a return before inflation going forward that is double bonds so be careful jumping to conclusions!

Gross argues that the 6.6% real appreciation (inflation adjusted return) of stocks presented in Siegel's book is "an historical freak, a mutation never to be seen again as far as we mortals are concerned."
  • The long-term history of inflation adjusted returns from stocks shows a persistent but recently fading 6.6% real return since 1912.
  • 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.
Gross makes many excellent arguments why he believes both the past 6.6% inflation adjusted return for stocks and the very recent high annual returns for bond funds will not continue going forward. I can't tell you how important it is to understand his arguments even if you agree with Siegel on why he thinks stocks can continue to return 6.6% real return going forward.

In the article where Gross writes why he thinks pension funds are still too optimistic with 4.75% and higher appreciation targets, Gross gives his "new Normal" target for a diversified portfolio of 50% stocks and 50% bonds:
  • 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.
Sadly, I pretty much agree with this assessment. Stock could probably do a bit better with GDP at 2.5% for the next decade and a dividend of maybe another 2.5% for a total of 5.0% but 6.6% after inflation will be tough unless investors suddenly flock to stocks again and drive up their valuation as happened in 1999 and early 2000 where the PE of the S&P500 got to 30!

Implications of lower returns:  What it means is all the "Monte Carlo" simulations that try to predict what a "safe withdrawal rate" is for a PASSIVE portfolio use old data that cannot be repeated going forward.   It also means that all the under funded pension obligations we read about are in far worse shape than they say because the pension funds, such as CalPERS in California, are still using 7% or more for their expected total portfolio returns.  (See CalSTRS Teachers Pension Fund Asset Allocation and
CalPERS Asset Allocation Ratio and Target Annual Return.)
On June 23, 2011, Joe Dear told CNBC the Target annual return for the CalPERS fund is 7.75%.  Joe says they probably can not meet this using US equities and fixed income but he thinks they can do it if they invest globally.
(International funds are sure not doing well of late....)
To get an annual return greater than zero going forward, investors will have to employ many tactics to scratch and scrape for each and every bit of extra 0.5% to 1.0% of return.  These tactics include:
  • Active portfolio rebalancing to sell high and buy low when your portfolio reaches targets rather than once a year.  See my article "Using Asset Allocation to Make Money in a Flat Market" for details.
  • Stock Selection:  If you look at my "Explore Portfolio Returns" you see that I've done very well during one of the most difficult periods in history for equity investors. BY DESIGN I don't follow the index funds so some years I do better and some years not as well as the index funds but since 1998 I have more than tripled the average annual return of the stock market (8.9% vs 2.6%) and more than doubled the return of legendary Warren Buffett (8.9% vs 4.5%)
  • To get added return, take profits in the explore portfolio when it is up to build up a bigger core.  Likewise, when the explore is down, move some funds from the core portfolio into the explore portfolio.

Of course, this is a lot more work than having a balanced retirement portfolio that used to allow 3% to 5% annual take-outs that many financial advisers and pension funds still hope to get.   If Gross is right, taking 5% a year out of a portfolio that is only generating 3% a year annual return will have you out of money sooner than you think using the old data.

Real Return on Stocks vs Bonds 1912 to 2012
Real Return on Stocks vs Bonds 1900 to 2012

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