Article Spotlight: Read the Article
“The cult of equity is dying,” William Gross, founder and co-CIO of PIMCO, claims in his latest Investment Outlook. He goes as far as comparing the 6.6% historical real return of equities to a “Ponzi scheme.” His theory is that because real GDP has historically increased at 3.5% annually during the same period that equities returned 6.6%, continued growth of stock prices in excess of the real growth rate is unsustainable. He goes on to ask:
If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)?
Gross warns that the 6.6% real return is a “historical freak”, something that won’t be seen ever again. We have seen bold calls similar to this in the past. BusinessWeek Magazine ran a story titled “The Death of Equities”in 1979. Since that article was published, equities have had a strong performance, with the S&P 500 returning over 11% annually during that period.
Many experts and casual observers like to throw out their opinions as facts and will often be proven wrong with enough time. It is important to discount the constant stream of investment noise from the financial media and have an investment policy statement in place. At Empirical Wealth Management, we develop an investment policy statement for every client, laying out a clear strategy for all market conditions. When stock market volatility rises or we are in a period of low returns, we can consult this document to help our clients stay on course in order to remain financially sound.
Ben Inker, Head of Asset Allocation at GMO, recently wrote a White Paper titled “Reports of the Death of Equities Have Been Greatly Exaggerated: Explaining Equity Returns.” In the White Paper, he explains the sources of equities returns and explores various trends between stock market returns and GDP growth. Below are the summary points from Mr. Inker’s report:
- GDP growth and stock market returns do not have any particularly obvious relationship, either empirically or in theory.
- Stock market returns can be significantly higher than GDP growth in perpetuity without leading to any economic absurdities.
- The most plausible reason to expect a substantial equity risk premium going forward is the extremely inconvenient times that equity markets tend to lose investors’ money.
- The only time it is rational to expect that equities will give their long-term risk premium is when the pricing of the stock market gives enough cash flow to shareholders to fund that return.
- Disappointing returns from equity markets over a period of time should not be viewed as a signal of the “death of equities.” Such losses are necessary for overpriced equity markets to revert to sustainable levels, and are therefore a necessary condition for the long-term return to equities to be stable.
For more on Mr. Gross and possible equity returns over the next decade, please see our third quarter newsletter from this year.
