“The cult of equity is dead.” – Bill Gross, CIO of PIMCO & manager of the world’s largest bond fund
Perhaps the most famous spectacularly incorrect forecast was the August 13, 1979 BusinessWeek article titled “The Death of Equities”. It signaled the start of one of the greatest bull markets in history with the S&P500 rising 2,635% from 1980-99.1
That is why I was surprised to see a financial heavyweight like Bill Gross making the same forecast now. Will this forecast signal the start of the next great bull market?
Forecasts like this are worth understanding because they reveal deeper truths.
First, let me tell you what was said and then I’ll explain why I think he is wrong and what this should tell us.
What was this high profile debate?
The quote: “The cult of equity is dead” in Bill Gross’ annual report led to an entertaining, high profile debate during interviews on Bloomberg2 with another financial heavyweight, Prof. Jeremy Siegel, Wharton finance professor and author of “Stocks for the Long Run”. In his monthly investment outlook July 31, Gross said that the so-called “Siegel Constant” (see Chart 1), which shows a long term history of equity real returns of 6.6 percent above inflation since 1912, may be a “historical freak” unlikely to be seen again.2 His reason is: “It’s hard to see how corporations and stocks can continue to earn 3 percent more than GDP going forward and that’s only common sense.”
Prof. Siegel’s response was that his research goes back to 1800 and the long term return of the stock market in the 1800s was similar to the 1900s 3. In addition, research by Dimson, Marsh & Staunton in the investment classic “Triumph of the Optimists” found that all 16 major industrialized countries in the world had similar stock market returns above inflation since 1900 3. History clearly supports the Siegel Constant.
How do we know Bill Gross is wrong?
The media billed it as a debate of heavyweights, but when you look at their reasons, it is clearly a different story. Jeremy Siegel’s evidence was 200 years of history in the US and 100 years of history in the 15 other major industrialized countries. Bill Gross’ evidence is a conclusion drawn from looking at one economic statistic (GDP). There is no comparison between the strength of their evidence.
Readers of my previous articles will know that I am a skeptic of people using the economy to try to forecast the stock market5. This is another clear example.
As an accountant, it is easy for me to see the flaw in Bill Gross’ argument. He compares the stock market to the gross domestic product (GDP) 4 and calls them both “wealth”. This is wrong. He is comparing an asset to an income. They are apples and oranges.
GDP is not “wealth”. It is wealth created during one year.
Comparing the stock market (an asset) to GDP (a measure of income) is like comparing your investments to your salary. Is it possible for your investments to increase faster than your salary? Of course. They are apples and oranges.
Why are such prominent forecasts consistently wrong?
The media is far more useful as a measure of popular sentiment than as source of accurate forecasts. Naturally, popular sentiment is most negative close to market lows or after extended periods of difficult markets. It is times like these that this type of forecast tends to be made.
The sentiment today is extremely negative, similar to 1979. The BusinessWeek story back in 1979 noted that: “At least seven million shareholders have defected from the stock market since 1970”. Recently, both the Financial Times (May 25) and The New York Times (May 28) have run stories on the flight of individual investors from stocks. The New York Times story of May 28, 2012 quotes a Gallup poll showing that the number of Americans invested in the stock market dropped to 53% in April 2012 from 65% in 2007. The 53% reading is the lowest since Gallup started asking the question in 1998.
The key point here is that negative popular sentiment and forecasts like the “Death of Equities” tend to happen closer to a market low than a market high.
At the other end of the scale, market highs tend to attract overly optimistic predictions. After the huge bull market of the 1990s, Harry Dent famously forecasted in his book “The Roaring 2000s” (October 14, 1999) that the DOW would reach 35,000 by 2008. At the time, the DOW was just over 11,000, so this forecast was that the market would more than triple in 9 years.
This type of bold, overly optimistic forecast tends to happen near market highs.
What should this tell us?
Should we take this forecast as an indication of the start of a new bull market?
Short term forecasts are always difficult, but long term stock market forecasts can be easy. This tells us that popular sentiment is far too negative today. This is good, because extreme negative sentiment tends to happen closer to market lows.
The evidence of history in the “Siegel Constant” is that the stock market consistently rises long term. Today, we also have the opportunity provided by extreme negative sentiment and positive signals like a forecast of the “Death of Equities”. This should tell us that it is a very good time to be invested.
1 Standard & Poor’s
3 Watch the interview with Jeremy Siegel here: http://www.bloomberg.com/video/siegel-on-ecb-decision-stocks-bonds-YhgQ9_jURkOmGiNUaqFgkw.html
4 Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a given period.