Wednesday, June 3, 2009

Bill Gross on Staying Rich as US Fortunes Decline (and a gift to our readers)

Update below.
From PIMCO via Research Recap:
The latest monthly letter from PIMCO’s Bill Gross, makes for depressing reading, especially for those who make their living off other people’s money.

Of one thing you can be sure however: over the next several decades, the ability to make a fortune by using other people’s money will be a lot harder.

Gross writes that it ” is probable that trillion-dollar deficits are here to stay because any recovery is likely to reflect “new normal” GDP growth rates of 1%-2% not 3%+ as we used to have. Staying rich in this future world will require strategies that reflect this altered vision of global economic growth and delevered financial markets. Bond investors should therefore confine maturities to the front end of yield curves where continuing low yields and downside price protection is more probable. Holders of dollars should diversify their own baskets before central banks and sovereign wealth funds ultimately do the same. ”
All investors should expect considerably lower rates of return than what they grew accustomed to only a few years ago. Staying rich in the “new normal” may not require investors to resemble Balzac as much as Will Rogers, who opined in the early 30s that he wasn’t as much concerned about the return on his money as the return of his money....MORE
Figuring out expected returns is one of my mission critical tasks, along with making coffee in the morning and turning out the lights when I leave at night.
So when I saw this morning's post at MarketBeat "Wharton’s Siegel: ‘A Time to Buy’':
...The operative question Robert Siegel put to the author of the book “Stocks for the Long Run” was this: Exactly how long a run are we talking here?:

Prof. SIEGEL: I’m virtually sure that it’s not going to be a long wait. And the reason is we’re no longer at high points in the market. In March, we were down more than 50 percent. And I looked all the way back last hundred years. Once you’re down 50 percent, your prospects are very good.

SIEGEL: You’re saying that the market dropped by so much over the past year that you’re saying, surely, this must have been the bottom back in March.

Prof. SIEGEL: Even in December of 1930, where you were 50 percent down from that all-time high in 1929, your five-year return was more than seven percent after inflation. The world looks different once you’re down as much as we have been down.

The professor pointed out dividends on stocks can be an attractive play for investors today, but also said that he’s not expecting another major shoe to drop in the markets....MORE
I added my two cents worth:

According to the Cowles Commission’s “COMMON-STOCK INDEXES 1871-1937″ the longest period of net decline in the index was 42 years. The longest period that included reinvested dividends was much shorter but it was a different time.
Dividend yields on common stocks averaged better than 5%. The last time that the dividend yield exceeded 5% was in 1982.
Since the March 9th low, the indicated dividend yield of the S&P 500 has dropped from 4.12% to a bit over 3%, I don’t know if divi’s are going to supply ammo to expected returns.
Just as important the risk premium that investors demanded in the period of the Cowles report was much higher. The recent 40% gains have shrunk the R.P. significantly.
Lastly, there is the simple question that MIT’s Zvi Bodie asked in the ’90’s:

“If the risk of negative returns decreases over time, why does the cost of long term puts increase?”
We posted some counter-arguments to Bodie at Climateer Investing but I’ve never forgotten the implications of his question.
Now I know that Warren Buffett took that bet but an analysis of what he was expecting would show it is as much an inflation bet as anything. Which means that should inflation bail him out, the inflation adjusted returns of his counterparty won’t be so hot.

UPDATE: Jeremy Siegel on Investing

Here's the gift. Yale has put the very difficult to find book online. As I said on a previous MarketBeat post:

What’s your data source, pre-1871?
I’ve got “COMMON-STOCK INDEXES 1871-1937″ open on the desk as I type and Mr. Cowles is quite explicit as to the reasons the Commission didn’t go further back than 1871. (pg. 4)
A big one is the paucity of publicly traded industrials.
During a mis-spent youth I read every line of the book.
My favorite tidbit is the listing, among the pre-1871 industrials, of New York Guano.
Some things never change.
Here’s Yale’s (and my) gift to MarketBeat’s readers:
It links to a big ‘ol hog of a PDF.