The Great Stock Fallacy
shocking stat in the article that follows - $1,000 invested in US Treasury 25-year zeroes, beginning in October 1981, rolled each year... today worth ~ $97,000... $1,000 invested in US stocks with dividends reinvested... today worth ~ $16,000... stocks for the long run, indeed...
forbes.com
The Great Stock Fallacy
A. Gary Shilling, 03.03.03, 12:00 AM ET
Despite the bear market, experts cling to the theory that stocks always win in the long run. Look at the last two decades and you will see how wrong that theory is.
The speculative binge of the 1990s, like any other, produced a cornucopia of investment fallacies. In retrospect the absurdities of some of them are obvious, such as the idea that we could all quit our jobs and make a living day trading, or the belief that companies should be evaluated on pro forma rather than GAAP results. But other wrongheaded concepts are still with us, and widely accepted.
Stocks are best. The theory is that, over a long enough period of time (say, a decade or two), stocks are guaranteed to beat bonds and cash. That's supposed to happen because corporate earnings are all but certain to grow faster than the economy, and price/earnings multiples will rise forever. A corollary is that market dips are opportunities to buy, not warnings to get out.
This theory won't work in the sober investment years ahead, any more than it did in the last three. Long run, profits on average can't grow faster than the economy. In a democracy, capital's share of the economic pie can't keep growing while labor's shrinks.
So what can we expect from the economy? Real annual GDP growth of 2.5% is plausible. With mild deflation of 1% to 2%, nominal growth would be a mere 1%. Ditto for stock appreciation with P/Es already contemplating deflation. Your total return on stocks is the sum of growth and yield. Stock yields average less than 2% now, maybe 3% in later years. Grand total return on a stock portfolio might be 3% to 4% a year.
Will that beat bonds? Almost certainly not. Long Treasurys now yield 5% (nominal), and that's your return if rates don't go up or down. If I am right that we will get mild deflation, then Treasury yields will come down, perhaps to 3%, providing a capital gain to today's buyers and outpacing the stock market.
Wall Street does not, of course, contemplate deflation. But suppose that the herd is right and we get 3% growth and 2% inflation. Then Treasury yields will be 5% or higher. But these high rates will eventually reflect themselves in lower P/Es for stocks. A 5% Treasury rate implies a market P/E of 17. Right now stocks are trading much higher, at 30 times trailing earnings. In this scenario stock prices simply must come down, and today's buyer will get a negative return.
Look for stock price appreciation of 1% to 5%, maybe less, for many years. A far cry from the 20%-plus of the late 1990s.
I don't buy the argument that you do well buying on dips. That dip may prove to be a chasm, and the rise beyond it not enough to make you whole. I also don't buy the argument that it's wrong to exit from the market when stocks are overpriced. With modest average growth in the years ahead, being out of bear markets will be more beneficial to your financial health than being in during bull phases. Remember, if you lose 50% on a stock, you have to double your money to get even.
Asset allocation is a precise science. Self-appointed experts still believe you can maximize your risk-adjusted return with X% in small-cap growth stocks, Y% in big-cap value, etc. And no cash--what I call pigeonhole investing. Where's the protection when every stock sector is down, as in 2002?
Portfolio managers brush aside negative showings and crow that they have beaten their benchmarks--the S&P 500, the Philadelphia Semiconductor index, whatever. But remember that your bank account is determined by absolute, not relative, performance. You shouldn't pay a manager, at least not for long, for beating his benchmarks if he's still losing your money.
Treasurys are for losers. Really? Over the past three calendar years the Lehman Brothers Long-Term Treasury index has averaged a positive 14% annual return; stocks, a negative 14%.
The spread in returns is also stunning over longer periods. If you bought a 25-year zero coupon Treasury bond in October 1981, when bonds were at their gloomiest point, then switched at the end of every calendar year to another 25-year zero, you'd have a compound annual return of 23.9%, before taxes or transaction costs. Starting with the S&P 500 stock index at its July 1982 low and reinvesting the dividends, you'd have enjoyed only a 13.9% annual return. Stocks gained only 18% as much as Treasury bonds.
I've been a Treasury bond bull since I started talking about the bond rally of a lifetime two decades ago (FORBES, May 23, 1983). There's more appreciation if mild deflation unfolds and pushes Treasury bond yields to 3%. A contraction in the long Treasury yield from 5% to 3% over the next two years would give you a compound annual total return of 23%. That's lots more than you can expect from stocks.
A. Gary Shilling is president of A. Gary Shilling & Co., economic consultants and investment advisers. Visit his homepage at www.forbes.com/shilling. |
