Money & Policy

Are Stocks Dead?

Legendary investor Bill Gross is down on equities. Should that affect the way you save for retirement?

“The cult of equity is dying.” That single sentence recently written by Bill Gross, the legendary bond guru and founder of the mutual fund behemoth Pimco, has sent shivers through investors. That’s because, to paraphrase the old E.F. Hutton line: When Gross talks, people listen.

So I want to tell you what he meant and whether you should give up on stocks (“equity” is just another word for “stock”), as some have interpreted Gross’s words.

Gross was referring to the investment gospel of the 1990s when financial advisers and money writers urged Americans to stash their retirement savings in stocks for superior long-term performance. Despite periodic swoons, the historical return of stocks more than compensated for the risk. For example, from 1946 to 1996 stocks rewarded patient investors with an average annual gain of about 10 percent. Bonds managed to do only about half as well.

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In the past decade or so, however, trust in the paradigm of lush stock returns has been badly battered. Financial scandals, from the Enron bankruptcy to the recent Peregrine Financial fraud, have eroded the equities-for-the-long-haul narrative. And small investors increasingly believe that the stock market is rigged against them in favor of insiders.

The Lost Decade for Stocks

But the main culprit behind the mistrust of equities has been performance. Over the past 10 years — what some money pundits have called “the lost decade” for stocks — the Standard & Poor’s 500 equity index had an average annual return of 6.34 percent, versus an 8.97 percent return for the Barclays U.S. Aggregate Government Long Bond index. Over the past five years, the average annual returns for those indices were just 1.13 percent for stocks and 12.25 percent for bonds.

Get used to it, says Gross. He believes stocks will continue to struggle, primarily because the economy is burdened with an enormous debt overhang, U.S. wages are on a four-decade-long decline and corporate profits are at peak levels. The notion that the best days for equities are behind us is reinforced by the baffling swirl of current events: A slowing U.S. economy. The fiscal cliff. The fight for the White House. Europe’s ongoing crisis. China’s economy sinking into a soft patch.
So is it time to break up with equities? Or, in the words of Neal Sedaka’s classic song “Breaking Up Is Hard to Do,” should we be making up again?

In the making-up camp: Seth J. Masters, chief investment officer at Bernstein Global Wealth Management, who disagrees with Gross. In a position paper, “The Case for the 20,000 Dow,” Masters estimates that investors can reasonably expect an 8 percent average annual return from stocks over the next 10 years. (The Dow has been hovering slightly above 13,100 lately.)

Among his supporting evidence is this striking set of numbers: Between 1901 and the beginning of the recent credit crisis, there have been 11 decade-long rolling periods in which bonds beat stocks — and, after each one, stocks outperformed bonds by an average of 5.8 percent.

“Some experts argue that the world has entered a ‘new normal’ condition in which stocks have permanently lost their return edge,” says Masters. “We’ve heard this before. It was wrong then and we think it’s wrong now, too.”

Advice for Your Retirement

So what are you supposed to do to save for your retirement (after pounding your head against the wall)? After all, here are two savvy finance mavens offering vastly different perspectives on the risks and rewards of stocks.

I have three reactions.

My first reaction to this debate is that timing matters. Over long periods of time, stocks should outperform bonds because they’ll reward investors for their extra risk.

Even if stocks beat bonds over the very long haul, however, what really counts is your own time frame: When do you plan on tapping retirement savings? Five years from now? A decade?

“Equities are an ugly asset class, one that is more likely than almost any other to lose investors a significant amount of money at those times when they can least afford it,” says Ben Inker, head of asset allocation at GMO, the Boston-based money manager. ”It is the reason why equities have been priced to deliver good returns historically,” he adds, in Reports of the Death of Equities Have Been Greatly Exaggerated: Explaining Equity Returns.

(MORE: How to Steer Clear of Investment Scams)

So you may want to assign a much higher probability of a potential equity bust around the time you stop working full-time. You don’t want to see your retirement savings vaporize because of a dramatic market drop.

My second reaction is that there is a more fruitful way to look at the debate between Gross and Masters.

Michael Mandel, chief economic strategist at the Progressive Policy Institute, notes that Gross's pessism is likely to be proven right in a world of slow innovation. However, Masters’s optimism is likely to be rewarded if the pace and impact of innovation steps up. For instance, advances in information technology could raise productivity in health care and education over the next decade. “In this view of the world, an investment in the stock market becomes a bet on innovation,” says Mandel.

Personally, I think we’re on the cusp of a wave of major breakthroughs. Information technologies are poised to transform the way we work and organize the workplace. It will be a "déjà vu all over again" moment for those who went through the introduction of the Internet at work.

No one knows for sure, of course, which is why it’s essential to keep your retirement savings diversified. Splitting your portfolio among stocks, bonds and what financial pros call “cash” (money market funds and bank CDs, for example) won’t protect your portfolio in the short run during the depths of a major financial catastrophe. The diversification will, however, smooth out your portfolio’s performance over time.

And that leads to my third and final reaction to Gross’s prognostication: The big message for anyone in their 50s or 60s saving for retirement is that you should become increasingly conservative with your investments, putting more of your portfolio into bonds as you age.

Chris Farrell
By Chris Farrell
Chris Farrell is senior economics contributor for American Public Media's Marketplace. An award-winning journalist, he is author
 of the books Purpose and a Paycheck:  Finding Meaning, Money and Happiness in the Second Half of Life and Unretirement: How Baby Boomers Are Changing the Way We Think About Work, Community, and The Good Life.@cfarrellecon

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