The world’s most famous bond fund manager says the “the cult of equity is dying” and projects minimal returns for both stocks and bonds over the next generation.
In his latest monthly report, Bill Gross dismisses those who believe that U.S. stocks can continue to produce average real returns of 6.6 per cent a year, saying that stock market bulls are failing to account for the much more difficult environment that now looms ahead for corporate profit growth.
“The legitimate question ... is how that 6.6 per cent real return can possibly be duplicated in the future given today’s initial conditions, which historically have never been more favourable for corporate profits,” writes Mr. Gross, co-chief investment officer of Pacific Investment Management Co. and portfolio manager for the $250-billion (U.S.) Pimco Total Return Fund.
Jeremy Siegel, an economist at the Wharton School at the University of Pennsylvania, looked at decades of data in his book Stocks for the Long Run to demonstrate that U.S. equities have historically produced robust returns in excess of 6 per cent a year after inflation.
Mr. Gross argues that those returns are unlikely to be duplicated in future, since corporate profits can not continue to exceed the 3.5 per cent average annual growth in U.S. GDP unless money is diverted from either wages or government.
Neither option seems likely. Washington is already running a massive deficit, while the share of U.S. GDP devoted to wages has been declining for 40 years, Mr. Gross says.
He believes the trend to lower wages, which has resulted from outsourcing manufacturing to low-wage countries, has largely run its course and is unlikely to provide a further boost to corporate profits.
Mr. Gross is not optimistic about the future for bonds either. Noting that Treasury yields are now hovering near historic lows, he says “it is even more of a stretch to assume that long term bonds ... will replicate the performance of decades past.”
Pimco is projecting that bonds will deliver 2 per cent annual returns in the years ahead, while stocks will produce 4 per cent returns. Once inflation is deducted, the return from a diversified portfolio would be roughly zero.
This would be disastrous for pension funds and insurance companies, which are counting on returns of seven to eight per cent to meet future commitments.
Mr. Gross expects that the U.S. government will have little choice but to spur inflation, writing, “the primary magic potion that policy makers have always applied in such a predicament is to inflate their way out of the corner.”