Bond king Bill Gross opened a Pandora’s box when he decided that the “cult of equity is dying.”
Citing a record low-interest policy from government as one of the main factors, Gross claims that both bonds and stocks are likely to face headwinds on account of inflation. According to Gross, “The cult of equity may be dying, but the cult of inflation may only have just begun.” He reiterated his ‘interesting’ remarks today.
According to Gross, investors should brace for annual returns of 3-4%, the new normal, in place of the hitherto double digit growth they have enjoyed.
Gross ventured into highly controversial territory, when he also went ahead and likened stocks to a Ponzi scheme, and further claimed that they reflect returns that are divorced from economic reality, such as underlying real GDP growth.
He asks, “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)?” ( …in the context of the 6.6% annual gain achieved on stocks since 1912)
He says, ”An investor, it seems, must learn a new dance to fit the diminished return size of the modern dance floor.”
Not surprisingly, these comments have drawn the ire of economists and fund managers the world over, and a rather comprehensive rejoinder to the debate has been issued by Ben Inker, head of Asset Allocation Group at GMO, which has AUM of $100 billion. His arguments against Gross’ thesis rest on the following planks:
- “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.”
Inker also takes issue with Gross’ comparison of equities to a Ponzi scheme, saying that investors are likely disillusioned with projected long terms on equities, because of the long period of 12 years, during which they have faced negative returns. Yet he remains confident that the markets would revert to historical trends, calling this period “an essential healing process for U.S. equities.”
Yet, for all his brow-beating of equities, Bill Gross’ firm PIMCO has recently ventured into stocks when, in 2009, they hired senior Treasury Department official Neel Kashkari to oversee their foray into equities. It may be noted that the size of the equity business is $6 billion – not a mean sum, but small in relation to its other assets under management, e.g. the bond fund, which is the largest in the world. The move into equities does not sit well with Gross’ views, and this may be more of the ‘talking-something-doing-something-else’ that Valuewalk pointed out here. In this article several instances have been identified when his actual trades have been very different from his public opinions.
Given this tendency to trade against himself, investors should perhaps take his public pronouncements, such as the death of equity, with a pinch of salt.