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Bill Gross: Equity Is Dying

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The long-term history of inflation-adjusted returns from stocks shows a persistent but recently fading 6.6% real return since 1912.

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Editor's Note: The following is an excerpt from PIMCO's Investment Outlook.

Several generations were weaned and in fact grew wealthier believing that pieces of paper representing "shares" of future profits were something more than a conditional IOU that came with risk. Hadn't history confirmed it?

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.

Got Stocks?

Chart 1 displays a rather different storyline, one which overwhelmingly favors stocks over a century's time – truly the long run. This long-term history of inflation adjusted returns from stocks shows a persistent but recently fading 6.6% real return (known as the Siegel constant) since 1912 that Generations X and Y perhaps should study more closely. Had they been alive in 1912 and lived to the ripe old age of 100, they would have turned what on the graph appears to be a $1 investment into more than $500 (inflation adjusted) over the interim. No wonder today's Boomers became Siegel disciples. Letting money do the hard work instead of working hard for the money was an historical inevitability it seemed.



Yet the 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes – a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. 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)? The commonsensical "illogic" of such an arrangement when carried forward another century to 2112 seems obvious as well. If stocks continue to appreciate at a 3% higher rate than the economy itself, then stockholders will command not only a disproportionate share of wealth, but nearly all of the money in the world! Owners of "shares" using the rather simple "rule of 72" would double their advantage every 24 years and in another century's time would have 16 times as much as the skeptics who decided to skip class and play hooky from the stock market.

The legitimate question that market analysts, government forecasters, and pension consultants should answer is how that 6.6% real return can possibly be duplicated in the future given today's initial conditions, which historically have never been more favorable for corporate profits. If labor and indeed government must demand some recompense for the four decade's long downward tilting teeter-totter of wealth creation, and if GDP growth itself is slowing significantly due to deleveraging in a New Normal economy, then how can stocks appreciate at 6.6% real? They cannot, absent a productivity miracle that resembles Apple's wizardry.

Got Bonds?

With long Treasuries currently yielding 2.55%, it is even more of a stretch to assume that long-term bonds – and the bond market – will replicate the performance of decades past.

The primary magic potion that policymakers have always applied in such a predicament is to inflate their way out of the corner. The easiest way to produce 7–8% yields for bonds over the next 30 years is to inflate them as quickly as possible to 7–8%!
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No positions in stocks mentioned.
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