Pimco Fund Manager Arnott Joins Bear Camp

Pimco's Robert Arnott, Legend Financial Advisors' Louis Stanasolovich and the editors of the influential No-Load Fund Analyst say it may be years, or even decades, before stocks return to their historic highs, making bonds more attractive investments.

After last year's stock-market crash, the long-term average returns of equities fell into the single digits. Large-company shares returned an annual average of 9.6% from 1926 through 2008, according to Ibbotson Associates. The gap to bonds has all but evaporated.

Financial advisers for years have clung to a key belief: Over the long term, stocks outdo bonds. While equities may suffer periodic slumps, they also produce tremendous growth. Now a growing minority of advisers and portfolio managers is taking a different view.

Among the most notable equity pessimists is Arnott, manager of Pimco All Asset(PASAX Quote), an $11.7 billion fund that has returned 3.7% annually during the five years through May 15, beating the S&P 500 Index by about 6 percentage points and outperforming 96% of its peers in Morningstar's moderate-allocation category.

Arnott worries that Washington has changed the rules of the financial markets in recent months. That will hurt stock prices for years to come, he says.

When companies defaulted in the past, secured bond holders were first in line to receive whatever assets remained, he says. Stock holders never worried that government interference would dilute the value of their holdings. But the Obama administration appears ready to stiff stock and bond holders as banks and auto makers restructure.

"We need to recognize that centuries of contract law have far less meaning than in the past," Arnott says. "This means that assets must be priced lower, with higher yields, to compensate for this new layer of risk."