“Investing is no longer child’s play”

Bill Gross, PIMCO’s chief investment officer, published his monthly investment outlook a few days ago. PIMCO is one of the largest bond fund managers in the world, and Gross’ newsletters are widely read and respected.

PIMCO's Bill Gross

PIMCO's Bill Gross

This month, Gross made a point that all investors should heed — especially those like me who have basically spent their entire lives traveling from one asset bubble or another:

Peter Bernstein has for several years counseled that policy portfolios structured for the long run and based on historical return statistics should be reconsidered. The standard pension or foundation approaches to policy portfolios are being challenged, he asserts, and PIMCO agrees. Stocks for the long run? Home prices that cannot go down? The inevitable levering of asset structures to double or quadruple returns relative to risk-free assets? These historical axioms must now be questioned. In fact, as of March 2009, the superiority of risk-asset returns are not what many assume them to be. For the past 10, 25, and 40 years, for example, total returns from bonds have exceeded those for common stocks…In short, our stereotyped conceptions of what makes money are being challenged. As Bernstein says, there is no predestined rate of return.

That emphasis was Gross’ by the way (He underlined it. I bolded it.).

It’s not hard to derive what this means for me and you, if you believe what he’s saying. Stocks’ historical 8% annual return? Meaningless. The “latte factor”? Dead. (Though, one could argue that David Bach’s gross oversimplification of the benefits of compound interest was misleading in the first place.) In other words, the core assumption that personal finance advice has relied on – whether it be from writers or financial planners – could just be plain wrong.

In retrospect, there’s no question that we’ve relied too much on a simple trendline to predict how stocks will perform over long periods of time. As one of my colleagues, Pat Regnier, put it a few months ago, you wouldn’t expect Microsoft to experience the same growth over the next 20 years as it did over the last 20, so why would you expect the U.S. stock market to keep performing as it has in the past?

So what could this new landscape look like? Gross believes investors will place a renewed value on earnings that reach their pockets, like dividends and bond payments. An investor would rather that his share of Microsoft send him a $2 dividend than hope that the share would increase $2 (or maybe even $3) in value. As such, there might be a renewed emphasis on companies with high dividend payments, and until stock dividend yields catch up with bond yields, bonds could be the preferred investment.

In short, investors’ wealth will only increase as fast as actual earnings increase. No more easy rides on speculative bull markets. “There should be no doubt that the bull markets as we’ve known them are over and that the revolution is on,” Gross writes. “Investing is no longer child’s play.”

– Joe Light


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