Bill Gross says the 'cult of equity is dying.' Is he right?
Bill Gross' name may be synonymous with bond investing, but PIMCO's co-founder and CIO isn’t shy about weighing in on equities. During the keynote address that kicked off the 2011 Morningstar Investment Conference, Gross suggested that, with interest rates at anemic levels and with inflation essentially having nowhere to go but up, income-seekers should favor high-quality dividend-paying stocks over most flavors of fixed income. Gross mentioned energy concern Southern Company
Some in the audience seemed surprised by Gross’ equity-centric comments, but that probably owed to his candor about the prospects for bonds. When the manager of PIMCO Total Return PTTRX--with assets in excess of a quarter trillion dollars--touts stocks over bonds, that's newsworthy even if the suggestion he made seemed merely sensible at the time.
This Year's Model
It seems sensible now, too. Yes, even the sturdiest of stocks will subject investors to more volatility than will investment-grade bonds. Yields on five -, seven-, and 10-year Treasuries are currently negative in real (inflation-adjusted) terms, though, and the 30-year Treasury bond pays a whopping 0.50%. Yields on corporate bonds are also paltry. The iShares iBoxx $ Invest Grade Corporate Bond
Topnotch actively managed mutual funds in Morningstar's intermediate-term bond category aren’t faring any better in terms of yield, either. Dodge & Cox Income
Long Live Stock
It’s a different story among equities, dividend-payers included. Despite a rally among income-producing stocks so strong that some are using the B word to describe it, disappointed fixed-income fans can still find compelling opportunities with attractive risk/reward profiles.
Johnson & Johnson, for example, currently yields roughly 3.5%, and trades in line with most of its historical price multiples. Daimler AG
Yet even though the advice Gross gave in 2011 still seems sound, he’s no longer offering it. With his characteristic gift for overstatement (and a newfound knack for Romantic poetry), Gross declares flatly in his most recent Investment Outlook, "The cult of equity is dying. 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."
Gross doesn’t have particularly high hopes for bonds, either. In his view, the prognosis for long-term Treasuries especially is, sticking with his metaphor, even more morbid.
Death, Be Not Proud
Is Gross right? It rarely pays to bet against him, but as we’ve seen, the year-over-year percentage change in his outlook can be substantial. Judging from flows into stock funds, moreover, the equity cult seems to be alive and kicking.
True, flows into bond funds have utterly swamped flows into equity vehicles in recent years. Also true, redemptions have been torrential for actively managed domestic-equity funds for several years running (though the hemorrhaging there seems to be subsiding). All told, Morningstar estimates that investors sent some $152.3 billion to equity mutual funds and ETFs between January 2009 and July 2012. Add flows into funds of funds, such as target-date offerings, and asset-allocation or "balanced" funds and the flows figure rises to $441.7 billion.
In the aftermath of the financial crisis, equity cultists are also becoming wealthier and perhaps smarter, too. In the trailing three years through August 2012, the merely average fund in Morningstar’s large-blend category has gained an annualized 11.4%. The passively managed Vanguard 500 Index
Moreover, while the ride has been rocky in the aftermath of the financial crisis, investors have been compensated for the risks they’ve taken by investing in equity vehicles. The average large-blend fund, for example, currently sports a trailing three-year Sortino Ratio--a volatility gauge that penalizes poor performance during downturns--well above the peer group’s historical average. That’s also true of the typical mid-cap blend and small-blend fund.
Equity valuations don’t look especially stretched either, at least not among large-caps. On an asset-weighted basis, SPDR S&P 500
Then, too, selective cases for individual stocks are almost always there for the making, a point that Gross himself would surely acknowledge. PIMCO, after all, does equity-fund business, too. Equity assets at the firm are dwarfed by the amount of bond-money PIMCO runs, but as with the industry at large, they’ve been increasing, too. Live long and prosper, equity cultists.