Equity is dying, said Bill Gross. For us it should be a buy signal

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Equity is dying, said Bill Gross. For us it should be a buy signal

by R Jagannathan 19 mins ago

#Bill Gross #EquityOutlook #PimcoPrint
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Pimco's Bill Gross prophesies death of equities

Here's something for investors to chew over. Bill Gross, iconic bond investor and co-founder of Pimco, has made a prophecy that has stunned investors in the US and elsewhere: he says both equity and bonds will be dud investments in the future.

"The cult of equity is dying," he says in his August investment outlook. As for bonds, he says it is highly unlikely that they will deliver positive real returns when governments are busy printing money to beat the downturn. He says bondholders should be happy with mere "survival"—that is maintaining the real value of their investments, and almost no inflation-adjusted positive returns.

Gross debunks the higher returns on equity over the last 100 years. Reuters

"What you see is what you get more often than not in the bond market, so momentum-following investors are bound to be disappointed if they look to the bond market's past 30-year history for future salvation, instead of mere survival at the current level of interest rates." (Read Gross' August report here, and critical comments on it here and here).

Gross debunks the higher returns on equity over the last 100 years (6.6 percent real returns over 1912-2012) as an aberration (a "historical freak").

He wrote: "The 6.6 percent real return belied a commonsensical flaw much like that of a chain letter or, yes—a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5 percent over the same period of time, then somehow stockholders must be skimming 3 percent off the top each and every year. If an economy's GDP could only provide 3.5 percent more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, labourers and government)?"

Gross is essentially hinting that capitalists made off with workers' booty – an unusual class war statement for a Wall Street wizard to make in an economic environment where the political arguments of the day are anyway about Wall Street Vs Main Street, and 99 percent Vs 1 percent.

He says the problems can be traced back to the last 40 years, when "real wage gains for labour have been declining as a percentage of GDP" – exactly the "stretch which has yielded the majority of the past century's real return advantage to stocks."

According to Gross, "Labour gaveth, capital tooketh away in part due to the significant shift to globalisation and the utilisation of cheaper emerging market labour. In addition, government has conceded a piece of their GDP share via lower taxes over the same time period."

Several questions arise from Gross devastating statements and gloomy prognosis for both equity and bonds.

First, are Gross' observations only about the US and Europe or also Asia and India?

Second, if both equity and bonds are going to be about mere "survival," where does one invest for real gains?

Third, what explains the contradiction between the established fact that equity has beaten fixed-income avenues over the long-term and Gross new-found pessimism?

Fourth, why should bonds be such a risk now that at best we can achieve mere capital safety?

Let's attempt some answers.

This writer believes that Gross' views are more relevant to the US, Europe and Japan, and less to Asia and especially India. Three reasons why.

One, the demographics of India are significantly favourable. This means growth will not stall in India and Asia, and it is being driven from below – a rising population and the demand pressures from a growing working age population.

Two, equity investment by the general public is very, very low—unlike the US. The US had 40 years of dramatic increases in equity flows driven by pension fund investments. Equity beat all other investment avenues over this long term primarily due to the sheer volume of money pouring into stocks. This is why returns were 6.6 percent when economic growth was 3.5 percent over the last 100 years.

In India, this 40-year period had just about begin in the last decade and aborted – as the outflows from equity funds show. When more money moves into equity, liquidity and demand will drive stock prices higher. Add western capital seeking a higher return in growth markets, and we should see a significant rise in equity values over the next decade.

In fact, Gross' statement that "the cult of equity is dying" in the US is a signal that it may now begin to take root here. As equity holdings are broadbased through greater pension fund investments, stock prices have nowhere to go but up.

Three, on bonds, though, Gross may be more right, for Indian governments tend to be careless about created money – printing more notes through deficit financing. So inflation will remain a long-term threat to bond returns here. In the short term, though, as the world slows, the 8-10 percent pre-tax returns now available on fixed-income avenues (FDs, tax-free bonds, and even government bonds) will improve as the global slowdown brings down commodity prices and interest rates start moving down.

On the other question— if both equity and bonds are going to be about mere "survival", where does one invest for real gains?—the answer is clearer. Equity will give good returns over the long term in India, but one needs to balance it with investments in gold—that traditional hedge against uncertainty—and some AAA bonds. Land investments will yield gains, but built property (like flats) prices are still too overpriced and largely the result of a rigged market. If the economic situation worsens, we could also see a crash in realty prices.

Overall, Gross' observations, if they turn out to be true, amount to a signal to buy equity in India. However, one has to balance this with the short-term reality of a blundering government and elections. The bottomline: invest in equity only for returns after 2014.
Equity is dying, said Bill Gross. For us it should be a buy signal | Firstpost
 

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