Bill Gross is talking up a painful yet obvious theory in his August 2012 Investment Outlook: the death of equities as a reliable investment class. Gross said, “The cult of equity is dying.” If you look through the report, what Gross is really calling for with bond rates now so low is that the death of real returns may be upon us.  Policymakers may only have self-inflicted inflation as a way out.

Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of “stocks for the long run” or any run have mellowed as well. I “tweeted” last month that the souring attitude might be a generational thing: “Boomers can’t take risk. Gen X and Y believe in Facebook but not its stock. Gen Z has no money.”

The bond king pointed out that an investor can periodically compare the return of stocks for the past 10, 20 and 30 years, and find that long-term Treasury bonds have been the higher returning and obviously “safer” investment than a diversified portfolio of equities.

What is interesting is that Gross is talking about the very long-term historical rate of return in stocks being 6.6% if you go back to say 1912.  In the 1990’s most pension funds were calling for return minimums of 8% or even 10% in equities.

Fortunately, Gross is also realistic about bond rates.  Had he not included this he would have been far too self-serving.  Gross said, “With long Treasuries currently yielding 2.55%, it is even more of a stretch to assume that long-term bonds – and the bond market – will replicate the performance of decades past.”

The following is a very much worse outlook: a presumed 2% return for bonds and a historically low percentage nominal return for stocks of 4%, for a nominal return of 3% and an expected inflation adjusted return near zero.

Gross noted, “The commonsensical conclusion is clear: If financial assets no longer work for you at a rate far and above the rate of true wealth creation, then you must work longer for your money, suffer a haircut on your existing holdings and entitlements, or both.”

There is one final warning and here and it is the most logical one that backs all this buying and selling of gold ahead.  This is the self-inflected inflation warning: “Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades… The cult of equity may be dying, but the cult of inflation may only have just begun.”

FULL COMMENTARY

JON C. OGG

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