SKARBECK: Are equities really dead? Depends on whom you ask

September 8, 2012

Ken Skarbeck InvestingReferences to the infamous 1979 Business Week article “The Death of Equities” have resurfaced in the media.

Last month, PIMCO’s Bill Gross, also known as the Bond King, proclaimed that “the cult of equity is dying.” A few weeks later, asset manager Ben Inker of GMO countered with a white paper titled, “Reports of the Death of Equities Have Been Greatly Exaggerated.”

This debate holds important ramifications since future investment returns will be a key factor in the quality of retirement for this generation—and perhaps the standard of living for future generations.

PIMCO originated the term “new normal,” which submits that investors are in for a period of subpar economic growth as global economies deleverage.

In his August missive, Gross says the equity cult surrounding Wharton professor Jeremy Siegel’s 1994 book “Stocks for the Long Run” was ill-timed. He suggests the book’s central conclusion—that stocks have generated a 6.6-percent real return (after inflation) since 1912—has been fading. In fact, Gross points out that long-term Treasury bonds have outperformed stocks over the past 10-, 20- and 30-year periods and were “safer” investments to boot.

Despite the performance edge bonds have had over stocks, Gross doesn’t forecast a particularly rosy future for bond returns, either. He sees new normal returns of about 2 percent for bonds and maybe 4 percent nominal returns for stocks. For a stock-and-bond portfolio that generates a 3-percent nominal return, Gross predicts an inflation-adjusted return near zero.

Under this scenario, economies will react to the austerity by cutting promised pensions and other retirement benefits. And people will work longer since investment returns will not deliver the nest egg needed for traditional retirement.

Finally, Gross believes politicians will cave in and resort to the undesirable solution of inflating their way out of our debts—saying the easiest way to get back to 7-percent yields on bonds is to inflate them to 7 percent as quickly as possible. He notes this will crush long-term bondholders and equity investors also will fare poorly since inflation doesn’t create real wealth.

Inker of GMO begins his counterattack stating that there actually is no relationship between GDP growth and stock returns. Oddly, Inker’s charts demonstrate that, if anything, higher growth has been associated with lower stock-market returns.

Inker also acknowledges the 6.6-percent real return stocks have provided over the very long term, but points out there were times that stock investors were miserable.

Depressions, wars, oil shocks and the global financial crisis were trying periods for investors. They were compensated for those risks with the higher returns equities have provided, and today is no exception. Inker estimates that long-term equity returns will approach 6 percent, in line with historic returns. Bonds are expected to return 2.5 percent to 3 percent and cash 1.5 percent to 2 percent.

Two respectable investment firms have two very different long-term forecasts. Our philosophy has simply been that investors should buy when prices are out of favor and cheap, and conversely sell when they become too popular.

That basic principle has produced satisfactory results ad infinitum.•


Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.


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