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Are the salad days over for U.S. stocks? For 15 years, we’ve seen the strongest, most dynamic bull market in American history. From 1983 through 1996, big company stocks rose 16.5 percent a year, according to the investment firm, Goldman Sachs.
But trees don’t grow to the sky. At some point, the market will settle down to single-digit gains.
William Gross, founder and chief investment officer of the Pacific Investment Management Co. in Newport Beach, thinks that time is now.
Gross manages the highly successful Pimco funds, which specialize in bonds. Bonds, too, have experienced a stunning bull market. Since1983, long-term Treasuries have risen an average of 11.6 percent ayear. (When interest rates fall, the market value of bonds and bond mutual funds goes up.)
Falling interest rates are the engine that drove the Dow Jones industrial average from a low of 1,086 in 1984 to more than 7,000 this year, before stocks began their recent slide. Low rates make stocks more valuable across the board. They also raise profits by lowering corporate borrowing costs.
But the conditions behind that stupendous market rise are now behind us. In Gross’ opinion, Treasuries will zigzag between roughly 7 percent, where they stand today, and 5 percent. That still leaves room for gains in stocks but not the double-digit bonanzas that have come to seem routine.
Going forward, stocks are going to be driven primarily by the rate of economic growth rather than falling interest rates. And growth will continue to be mild.
Over the next three to five years, Gross foresees real growth in the placid 2 percent to 3 percent range, with inflation hovering around 2 percent.
In such an environment, he says, stocks might average around 8 percent a year, including dividends. Bonds might yield around 7 percent.
He could be wrong, of course. If the baby boomers keep pouring their retirement money into stocks, prices may move higher than he expects.
But if he’s right, investors counting on 16 percent gains to fatten their retirement funds are going to be bitterly disappointed.
Slow economic growth, Gross says, is baked in the cake and with it, slower stock market gains. The government couldn’t change things even if it tried.
For example, say that Congress force-fed the economy by boosting deficit spending a trick that has worked in the past. The world’s bond traders would stop the spenders dead in their tracks. They’d sell bonds and drive up interest rates, which would slow the economy down again.
Another reason growth is slow is demographic. Every year, there are fewer and fewer people age 20 to 29, as the “baby bust”generation relatively small in number leaves school and enters thework force. Fewer young adults means less consumer spending, and consumers account for 70 percent of the American economy.
Even if U.S. stocks revert to modest levels of growth, they should yield more than bonds, over the long term. But Gross has some other suggestions, too, laid out in his new book, “Everything You’ve Heard About Investing Is Wrong” (Random House; $24). Among them:
1) Emerging markets, which are growing at a rapid pace. Look at diversified mutual funds, whose managers keep track of what’s happening in Latin America, Asia and Eastern Europe.
2) Bonds or bond funds, which Gross thinks should be part of every portfolio (say, 10 percent in bonds for young people and 30 percent for the middle-aged). A 7 percent yield is highly competitive when stocks are slowing down. He’s especially fond of long-term corporates and Ginnie Maes.
3) For money you’ll need in a year or two, consider short-term bond funds or adjustable-rate mortgage funds rather than money market funds. You take a small risk that share values will drop. But in return you earn around 6.5 percent, compared with 4.5 percent in money funds.
4) No-load (no sales charge) mutual funds with low money-management and administrative fees. When your stock fund is up 16 percent a year, a 1.5 percent annual fee seems like peanuts. But when stocks are up only 8 percent, that fee eats up 19 percent of your gain.
Gross thinks you should pay no more than 0.75 percent a year for foreign stock funds, 0.65 percent for U.S. stock funds and 0.5 percent for bond funds. Two possibilities: the index funds at the Vanguard Group in Valley Forge, Pa., and Gross’ Pimco funds when bought through discount stockbrokers like Charles Schwab and Jack White.
Changing the CPI
Congress and the White House are having second thoughts about changing the way the government figures cost-of-living increases. Many programs are indexed to the Consumer Price Index (CPI), but most experts think the CPI overstates the real rise in the cost of living.
By revising the way it indexes payments, the government could produce a quick budget fix. It would nip a few dollars out of almost everyone’s pocket but ease the pressure on Medicare and other popular programs.
The most recent report on the CPI, headed by economist Michael Boskin of the Hoover Institution at Stanford University, estimates that it overstates the average cost of living by 1.1 percentage points a year (with a range of 0.8 percent to 1.6 percent).
If Congress cut, say, 0.5 percentage points from the cost-of-living adjustment, here’s what would happen:
– Social Security payments would be a little bit lower. If your monthly benefit came to $745 last year, your check is projected to rise this year to $768. A reduction of 0.5 percent would leave you with $765–a loss of $3 a month, $36 for the year.
– Other federal payments would similarly be shaved: federal and military pensions, indexed veterans benefits, and Supplemental Security Income.
– The official poverty line would rise a tad more slowly, as would certain poverty programs. For example, the amount of food stamps an eligible person gets is linked to the level of the CPI.
– Income-tax payments would rise a speck. Personal exemptions, income-tax brackets, the standard deduction and the earned income credit are all indexed to inflation. If they go up more slowly, a little bit more of your income would be subject to tax.
All the federal changes would be small. But taken together (and assuming no compensating rise in federal spending), they could trim the deficit by $14 billion in 2000 and $51 billion in 2005, according to the Congressional Budget Office.
Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.
