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Sorry Bill Gross, But You're Dead Wrong
August 2, 2012
Bill Gross is getting feisty. The bond guru took shots at the economy, 100-year historical stock patterns, personally called out legendary Wharton professor Jeremy Siegel by likening his analysis of the stock market to a Ponzi scheme, and declared stocks dead.
The big declaration from Bill was that the 6.6% annual gain on an inflation-adjusted basis that the stock market has provided in the last 100 years is a "historical freak, a mutation likely never to be seen again."
Harsh words. But he's not just down on stocks, expecting them to return closer to 4% per year in the future; he also thinks that bonds are likely to be stuck in a 2% annual return pattern going forward. If you're evenly diversified between stocks and bonds, he says to expect inflation-adjusted returns of zero.
Bah, humbug. And by the way, you're out of your mind, Bill.
Without a doubt, Bill is a great investor. His economic analysis is often spot-on, and his firm has won big on several big macro calls in the past. And one thing that I like about Bill is that he speaks his mind. But in this case—as in several other times in recent past—he couldn't be more wrong.
In fact, this call is a curious case of d�já vu from his prediction back in October 2009. Bill said then:
"Investors must recognize that if assets appreciate with nominal GDP, a 4%–5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets—while still continuously supported by Fed and Treasury policymakers—is likely at its pinnacle."
Of course, the Dow went on to rally another 3,000 points over the next three years. But that's not all that makes me think Bill may be losing his macro touch.
He was wrong on his call last year regarding the Fed and Treasury bonds. He expected that bond yields would climb once the Fed stopped buying bonds under the QE2 program in June–in fact, we saw just the opposite happen as bond yields marched steadily lower.
And he was wrong back in 2002 when he called for the Dow to fall to 5,000. Instead, the market soared, peaking at 14,000 five years later.
So what is the right forecast of future stock returns? I don't have a crystal ball, but the market is much more attuned to earnings than it is to U.S. GDP growth. And for good reason, since Bill's argument that the stock market can't—or at least shouldn't—return more than U.S. GDP growth is much too simplistic. Nearly half of the S&P 500's revenues today are generated globally. Just 10 years ago, global revenues were closer to 30%.
Right now the S&P is trading at about 14 times earnings, a discount to its historical average, with an earnings yield of just over 7%—this is a company's earnings per share divided by its share price, and it's right now close to the highest on record when compared to yields offered by 10-year Treasury bonds.
The fact is that right now we are at an inflection point. The S&P 500 yields more than Treasury bonds for the first time in 55 years.
Tremendous buying opportunity barely scratches the surface when I think about what lies ahead for smart investors. With an average dividend yield of approximately 2.2%, the S&P 500 is an oasis for many yield-oriented investors, and reversion to the mean means that stocks are cheap and bonds are expensive. As investors chase yield, we're going to see liquidity improve and money literally pour into the market as it has no other place to go.
We've already seen buying pressure build for dividend stocks and I expect that to continue in the weeks, months and years to come. This is not going to be a fleeting trend. But you will want to get in now—in the early stages before the masses realize what's happening.
My advice to Bill Gross is to stick to bonds and leave the 1979 "Death to Equities" headlines to BusinessWeek. My advice to you is load up on as many fundamentally sound dividend stocks as possible. If you're not a member of one of my investing newsletters, you should consult Portfolio Grader immediately to grade each of your dividend stocks and to find new ones.