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Robert Powell's Your Portfolio
April 6, 2011, 12:01 a.m. EDT
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By Robert Powell, MarketWatch
BOSTON (MarketWatch) "” Don't buy stocks. Don't buy bonds.
It's not uncommon for money-management experts to have conflicting points of view. What's hard though is squaring up those opposing opinions and trying to figure out what to do with your own money given conflicting theories.
Case in point: The latest missives from two legendary investors, Rob Arnott and Bill Gross. The former argues against stocks for the long-term and the latter argues against bonds, or at least U.S. Treasurys.
Arnott, the chairman of Research Affiliates, examined in his latest newsletter the equity risk premium in the U.S. since 1802 and argued that "concentrating the majority of one's investment portfolio in one investment category (i.e. stocks), based on an unknowable and fickle long-term equity premium, is a dangerous game of "?probability chicken.'"
Meanwhile, Gross, the founder of Pacific Investment Management Co., known as PIMCO, and manager of its flagship Total Return Fund /quotes/comstock/10r!pttax (PTTAX 10.89, -0.02, -0.18%) , explained in his most recent newsletter that he had dumped his U.S. Treasury holdings at the end of February because he sees little value in the market given the nation's mounting debt burden.
For his part, Arnott, who coincidentally manages two broad-based PIMCO offerings "” All Asset Fund /quotes/comstock/10r!pasax (PASAX 12.38, +0.01, +0.08%) and All Asset Authority Fund /quotes/comstock/10r!pauax (PAUAX 10.82, +0.01, +0.09%) "” made the following case against betting one's life savings on stocks. Most professional and casual investors like to point to research that shows that U.S. stocks have delivered excess returns over long-term government bonds of 4.4% since 1926 or 2.8% since 1802. But the truth of the matter is that most investors don't have investment programs of 200-plus years or even 80-plus. Instead, the relevant time period for most investors are much shorter, 10 or 20 years, maybe even 30 years.
And when you look at the annualized returns of stocks vs. other assets over one, two and three decades, what you find is this: Investors aren't being rewarded for bearing the risk of holding stocks. In fact, the equity risk premium "” how much stocks gained in excess of U.S. government bonds "” for the 30-year period a measly 0.53%.
In other words, stocks market investors took the risk and got paid nothing in return. What's worse, "investors who have incurred the ups and downs over the past decade have lost money compared to what they could have earned from long-term government bonds," Arnott wrote. "They've paid for the privilege of incurring stomach-churning risk."
To be fair, Arnott did note in his newsletter that stocks do have a high tendency to outperform government bonds over 10- and 20-year periods.
For the vast majority of periods since 1926, equities outperform bonds "” 86% for 10 years and 96% for 20 years. And since 1802, equities even outperformed bonds over 10-year periods, though the data are less convincing. For 10-year periods, equities outperform in 71% of the observations, rising to 83% for 20 years.
But even those are fairly good odds, Arnott wrote, that the relatively small probability of failure masks the magnitude of a miss. "Just as a single missed free throw can cost a basketball championship, so too can an equity "?miss' lead to drastic consequences, as the past 10 years have shown. There is no guarantee of superior equity returns, which begs the question: Why does our industry act like there's one? More important, why take all that risk for a skinny equity premium?"
Bottom line: The much-vaunted 4% to 5% risk premium for stocks is "unreliable and a dangerous assumption on which to make our future plans," he wrote. Instead, expect a 2% to 3% risk premium during normal times and something much less than that during these not-so-normal times. "Today's low starting yields, combined with the prospective challenges from our addiction to debt-financed consumption and aging population, would put us closer to 1%," he wrote.
See Arnott's report, "The Biggest Urban Legend in Finance" at this website.
So if not stocks, perhaps bonds? That would be a big fat "no," according to PIMCO's Gross. In his latest newsletter, the federal budget deficit is a cause for concern, at least when it comes to U.S. Treasury securities. "Unless entitlements are substantially reformed, I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies "” inflation, currency devaluation and low to negative real interest rates," Gross wrote.
By the time you read this, your chances to make money off the rebalancing of the Nasdaq 100 are long gone, writes Chuck Jaffe.
2:30 p.m. April 5, 2011
"Hong Kong stocks seesaw in early trade after China rate hike; Hang Seng Index flat http://on.mktw.net/dKi8dp" 8:36 p.m. EDT, April 5, 2011 from MarketWatch
"Japan stocks open higher, but weakness in banks limits gains; Nikkei Average up 0.4% http://on.mktw.net/eByESQ" 7:07 p.m. EDT, April 5, 2011 from MarketWatch
"FTC may launch probe into #Google search http://bit.ly/fNAlKZ" 5:22 p.m. EDT, April 5, 2011 from MarketWatch
"Cephalon spurns Valeant's $5.7 billion offer as 'inadequate' http://on.mktw.net/gVATpV" 5:21 p.m. EDT, April 5, 2011 from MarketWatch
"RT @staceydelo: Got questions for investing in a post-crisis (or ongoing crisis) environment? Send 'em over to @marketwatch" 4:56 p.m. EDT, April 5, 2011 from MarketWatch
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