Bill Gross’ recent argument that the cult of equities is dying included one significant flaw, Henry Blodget writes on Yahoo! Finance’s Daily Ticker.
“Even brilliant people occasionally make boneheaded mistakes, and one of the world’s most prominent investors appears to have made a big one,” Blodget writes. In his recent commentary, Gross said that stocks cannot continue to appreciate in the 7% per year range forever while gross domestic product grows at about 3%; if it did, the stock market would soon be worth more than the entire world, Gross said. “At first blush, this seems like an obvious but profound observation, one that would make every equity strategist, scholar, and financial advisor who has ever cited the 7% long-term stock return (after adjusting for inflation) look and feel like a moron,” Blodget says. “Alas, it’s wrong.”
The mistake Gross makes, Blodget notes, is that “stocks have not, in fact, ‘appreciated’ at ~7% per year for the past couple hundred years. Stocks have only ‘appreciated’ about 2% per year. That is to say, the prices of stocks, after adjusting for inflation, have only risen about 2% per year for the past couple of centuries.” The rest of the return, he says, has come from dividends. “Companies have paid out cash to their shareholders, and these shareholders have either used the cash to buy more shares (from someone else — not usually from the company) or used the cash to buy other stuff,” Blodget writes. “Either way, the dividend part of the stock ‘return’ is then recycled back into the economy.”
Blodget goes on to say that he expects stocks to earn significantly lower returns than they have in the past, but not because of the GDP argument. He says the market is overvalued relative to historical norms, while dividends are lower and profit margins are higher (and thus likely to fall), which will lead to the weaker performance.