One of the defining features of the last twenty years has been a persistent and fairly continuous belief that investing in the stock market was something of a sure road to wealth. The downturns in the stock market in the aftermath of the Tech bubble and, more recently, in the financial crisis, have shaken investors’ faith in the maxim that stocks are inevitably a good bet. The tendency of people to take it as an article of faith that equities will, ultimately, deliver high returns has been referred to as ‘the cult of equity.’ Two recent articles by experts that I respect propose that this phenomenon is dead or dying.
Two Voices, Same Conclusion
First, we have Bill Gross, proposing that the historical average returns from equities that form the foundation of our belief are the result of a unique period in history that cannot possibly be repeated. He argues that a combination of very low corporate tax rates and an increased flow of corporate profits to shareholders at the expense of workers, in combination with consistently low interest rates, have enabled companies to generate unsustainably high returns to shareholders. He also argues that all of these effects have run their course and that, inevitably, shareholder returns cannot be nearly as high in the coming years as they have in the past. Gross also makes reference to the impact of U.S. demographics on expected returns from stocks, proposing that Boomers are reaching an age where they cannot afford to take the risks associated with equities, Gen X and Gen Y simply don’t believe in the narrative that favors stocks, and Gen Z has no money to invest. I explored the issue of demographics on expected stock market performance in a recent post. Gross’ argument here is in alignment with a range of other data.
David Rosenberg, chief economist and strategist at Gluskin Sheff just issued his pronouncement that ‘the cult of equity is clearly over.’ By way of evidence, he focuses on the massive outflows of investor money from equity mutual funds. His thinking also reflects demography as a key driver. He wrote that ‘the secular shift in investor behavior towards income generation continues apace.’ It makes perfect sense that aging Boomers’ increased focus on how to generate income in retirement (as opposed to growth during their earning and saving years) and that this shift will favor asset classes that provide higher levels of income than the stock market as a whole.
How Does This Change Our Outlook?
Frankly, neither of these two pieces alters my own outlook on asset allocation. I agree completely with Gross that the very high returns from stocks over the past decades are not something that a rational person will bet on for the future. This does not mean that investors should dump stocks, however---even older investors such as Boomers. The 2010 Moderate Target Date Folio, an asset allocation designed for people retiring at or around the year 2010, holds 15% in Vanguard’s Information Technology ETF (VGT) and 15% in Vanguard’s Equity Energy ETF (VDE), along with two municipal bond ETFs (MUB at 12.75% of the portfolio and PZA at 15%).
If we find Sheff’s and Gross’ arguments compelling, why would it make sense to maintain a 30% or higher allocation to stocks? First and foremost, every market prediction is suspect, no matter who makes it. I include my own outlooks in this blanket indictment. We must always maintain a healthy skepticism about anyone’s ability to predict returns from any asset class. The most recent three years provide a case in point. As I write this, the trailing twelve-month yield of the S&P500 is at 1.98% (considerably higher than the anemic 1.5% yield of 10-year Treasuries), and the trailing 3-year total return for SPY (which tracks the S&P500) is 14.3% per year and the trailing 10-year return for SPY is 6.3% per year. The Barclays Aggregate Bond Index is up by 7.1% per year over the past three years and 5.7% per year over the past ten years. The 2010 Moderate Target Date Folio has an annualized return of 10.7% over the past three years.
Another reason to keep an allocation to equities, even if you don’t think equities will perform particularly well going forward, is that equities and fixed income (stocks and bonds) provide considerable diversification benefit when combined in a portfolio. While I have seen many claims that the value of diversification has disappeared, diversifying across asset classes has provided considerable value even during the worst market conditions.
Ultimately, investors should hold a variety of fixed income asset classes (Treasury bonds, corporate bonds, and municipal bonds) as well as a mix of higher-risk asset classes (domestic and international stocks, REITS, and commodities). While I agree with both Rosenberg and Gross that returns from stocks are likely to be modest, I simply do not believe that most investors will be well-served by attempting to bet on such a prediction.
The Holdings in the 2010 Moderate Target Date Folio
The current holdings of the 2010 Moderate Target Date Folio are shown below:
|Vanguard Intermediate-Term Bond ETF||BIV||3.25%|
|Vanguard Total Bond Market ETF||BND||1.75%|
|Vanguard Short-Term Bond ETF||BSV||11.25%|
|PowerShares DB Commodity Index Tracking||DBC||11.75%|
|Vanguard Extended Dur TRD Index ETF||EDV||9.00%|
|iShares iBoxx$ Invest Grade Corp Bond||LQD||1.00%|
|iShares S&P National AMT-Free Muni BD||MUB||12.75%|
|PowerShares Insured National Muni Bond||PZA||15.00%|
|iShares Barclays TIPS Bond||TIP||4.00%|
|Vanguard Energy ETF||VDE||15.00%|
|Vanguard Information Technology ETF||VGT||15.00%|
|Vanguard Utilities ETF||VPU||0.25%|
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