Gauging the 'Bill Gross Effect' for Stocks

How much attention should you pay to gloomy market forecasts?

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Why do we listen to stock market forecasts?

Because we can. Forecast, that is. Anyone can do it.

The experts are wrong as often as they are right, studies show. And who remembers what someone said about the market six months or a year back?

Still, we listen, especially when an investor of Bill Gross's stature speaks. The Pimco head bond guru stands out for both his investing skill and his attention-grabbing market letters. To be sure, his investing record is among the best. But his big calls on the market are peppered with some big-time misses.

In the latest Big Call, he did not so much make a forecast as serve a death notice on the market, writing in his monthly investment outlook that "the cult of equity is dead" and likening equities to "a Ponzi scheme."

Gross, of course, is a bond guy, and for that reason alone, some people dismissed his August advisory. Indeed, it's been a solid month for stocks, and there is no consensus that the market is showing signs of any big moves either way based on valuations and technical factors.

"The truth is that, as usual, nobody has a clue where the market or the economy is going," says Hugh Johnson, chief executive of Hugh Johnson Advisors. "But that doesn't stop us from forecasting." 

For fund managers and analysts, it's all about getting noticed. So bolder is better. If you can be right about the future, all the better. But it's not a requirement. 

Because Gross is so well-known, even his tamest forecasts get picked up by the media. This one sent news wires and financial television into full spin, with Gross tweeting suggestions that there has been a deep culture change in the population of investors now coming of age.

"Boomers can't take risk. Gen X and Y believe in Facebook but not its stock. Gen Z has no money," Gross said.

But in this case, it was the colorful language, not the message, that was bold.

The Gross forecast. His key point was that investment returns going forward will not match the past. That would not surprise anyone, since returns on most investments are at historic lows.

"Most forecasts are extrapolations," says Johnson. That is surely true of Gross's latest.

Gross's bottom line? "A presumed 2% return for bonds and an historically low percentage nominal return for stocks—call it 4%, when combined in a diversified portfolio produce a nominal return of 3% and an expected inflation adjusted return near zero. "

That does not sound quite as dire and prophetic as "death of equities." Indeed, few would argue that returns are going to be lower for many investments. Gross also won't get much argument on the other part of his note, that inflation will rise as governments pour cash into their economies to cope with slow growth and high debt, although it has not been seen so far. He kept underlining the word "nominal" because that figure is not adjusted for inflation, something that needs to be taken into account in deciding investments.

But Gross did go a step further, saying that the best-known proponent of long-term investing, University of Pennsylvania finance professor Jeremy Siegel, had things wrong in his seminal work on stock market's long-term potential. Gross argued that the stock market has been rising at 3 percent above the rate of economic growth, something which cannot be sustained.

"The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned," Gross said.

It's the kind of colorful, clever language that delivers an audience. Gross is effective at getting his message out—a Google search shows 40 million results for Bill Gross. Warren Buffett generates 6 million.

The record on forecasts. His record of beating benchmarks year after year with his main fund, Pimco Total Return, makes him quotable. But his crystal ball is no clearer than anyone else's. Birinyi Associates, the stocks research service, charted his calls over a decade and found a few hits and some big misses.

He made a series of negative forecasts in 2003 and 2004 saying stocks were overvalued by 20 percent to 25 percent, Birinyi notes. Stock prices nearly doubled the next two years.