Say good-bye to the days of double-digit returns from your stock and bond investments. We have crossed the threshold into an "age of diminished expectations" during which equity and fixed-income investments will gain little more than 5% annually over the next few years, said Bill Gross, manager of PIMCO Total Return.
Gross, who was the keynote speaker Tuesday at Morningstar's 2001 Investment Conference in Chicago, gently chided the audience of financial advisors, investors, and mutual-fund industry players like a parent delicately trying to tell a child to get real. He said the financial bubbles that fueled heady gains of the latter half of the 1990's are collapsing, and anyone who expects 10% returns will be disappointed.
"We are moving into an age of what I call diminished expectations, in which double-digit returns will no longer be with us over a long period of time," Gross said.
In a time of thin gains, advisors and investors should pay more attention to the structure of their portfolios--especially fees, said Gross, PIMCO's founder and managing director. If Gross's prediction comes true and returns are around 5% per year, then a mutual-fund expense ratio of 1% will consume about one fifth of an investor's annual gains. "In this day and age when returns are no longer in the double digits, those 1% fees make a whale of a difference in terms of returns going forward," said Gross, two-time winner of Morningstar's Fixed Income Manager of the Year.
Investor exuberance
Speculative excess in financial markets and in the economy in the late 1990s was caused by several forces, Gross said. Investors were exuberant about the new economy and the potential for enhanced corporate productivity and profits, so they paid too dearly for Nasdaq Composite stocks like Cisco Systems CSCO. Lenders advanced too much money to Internet firms with dubious business plans and telecommunications companies building fiber-optic networks to handle a deluge of traffic that has yet to materialize. Consumers, inebriated with fantastic portfolio gains, spent too much and saved too little. That helped strengthen the dollar, and a flood of imports threw the nation's trade balance further out of whack. "We overdid it," Gross said.
Those bubbles are deflating now, and it's remotely possible the nation could descend into the type of severe economic malaise that afflicted the United States during the Depression, and has plagued Japan for the last decade. "All these bubbles have to pay back some of what they took," Gross said.
But wait--get off that window ledge. Gross thinks America's institutions, such as the Federal Reserve, are well aware of what can happen and are prepared to prevent the economy from sliding that far.
Still, Gross said equity values need to come down, Americans need to increase their savings rate, and corporations that have excess inventory must rein in investments. Tempering consumer spending and technology investments alone will be enough to slow gross domestic product (GDP) growth to 2% instead of the 4% to 5% of recent years, Gross said. Corporate profits tend to mimic the GDP over time, so if you add in 2% for inflation and a 1% dividend yield for stocks, you get a equity return of about 5%, Gross said.
On the bond side, Gross thinks the current yield of about 5% on the 10-year Treasury bond is a good predictor for the next three or four years. "Bonds signal what's ahead in terms of total return," he said.
In closing, Gross qouted humorist Will Rogers, who, when asked about the stock market, once replied that he was not as concerned about the return ON his money as he was about the return OF his money. How's that for a battle cry for an "age of diminished expectations"?
This article was first published on www.morningstar.com on June 26th 2001. Please note when the text refers to a specific, US domiciled, investment fund it may not be available to European investors.
The Morningstar investment conference took place from June 25th-27th in Chicago. This year it was attended by almost 1200 delegates including fund managers, securities analysts and advisers. It has run annually since 1988.
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