Pimco's Gross Misses the Mark on Stocks

BOSTON (TheStreet) -- Pimco's legendary bond fund manager Bill Gross should probably stick with what he's best at -- managing a bond fund -- as his latest claim that stock investing is a dying "cult" may be mere fear mongering.

Gross' comments in his firm's August newsletter come at a time when risk-averse investors, still shaken by the 2008-2009 financial crisis, the long-running European debt crisis and the uncertain domestic economy, have been dumping stocks in favor of bonds for well over a year, a good thing for Gross, who runs the world's biggest bond fund.

The Pimco co-founder's basic thesis is that investors shouldn't expect anything near stocks' inflation-adjusted 6.6% annual return of the past century. He dramatically labels that performance as "a mutation likely never to be seen again as far as we mortals are concerned."

Gross, who's also the firm's investment chief, contends that the widely accepted 6.6% statistic, known as the "Siegel Constant," and based on the research of University of Pennsylvania professor Jeremy Siegel, contains a "commonsensical flaw," because in the 100-year period cited, "wealth or real GDP was only being created at an annual rate of 3.5%" and so to reach 6.6%, "somehow stockholders must be skimming 3% off the top each and every year."

Gross is similarly negative on bonds, noting that with long-term Treasuries currently yielding 2.55%, it's unlikely that "long-term bonds -- and the bond market -- will replicate the performance of decades past."

He concludes that under that scenario, a 2% return for long-term bonds and 4% return on stocks in a typical diversified portfolio would produce a nominal return of 3%, resulting in an inflation-adjusted return near zero, negating the benefits of investing.

But it didn't take long for Siegel to take Gross to task, telling several news outlets that Gross' thesis is false, because there is no direct link between stock market returns and trends in gross domestic product and that investment returns can, indeed, exceed the rate of economic growth. "The thing is that capital gives out dividends, it gives out interest, it gives out return. When you add that all together, it's going to be greater than GDP growth," Siegel told CNBC.

"Even in a no-growth economy, you're going to get some return on capital," said Siegel, "so it's not an anomaly, it's not inconsistent to have that phenomenon."

And it's worth noting that Gross has previously backed similar doom-and-gloom predictions, including in early 2009, when he said stocks and bonds would average no better than 4% to 5% annual appreciation in a "new normal" world of investing.

But since then, the benchmark S&P 500 has about doubled, returning 16.5% per year, which brings its total return over the past decade to an annualized 6.9%, or roughly in line with Siegel's research.

What's more, Gross made a bad bet in his own back yard only last year, when he announced a move out of U.S. Treasuries early in 2011 for his $270 billion Pimco Total Return Fund ( PTTRX). That caused it to miss out on a big summer bond rally, resulting in the top-rated fund's worst annual performance, which he labeled a "stinker."

Gross' comments come on the heels of similarly alarming claims from Peter Schiff, CEO and chief global strategist of Euro Pacific Capital, who said that despite government stimulus programs, the U.S. economy is heading for an economic collapse equivalent to that seen in Europe now. Schiff is well-known for accurately predicting the housing and financial crisis of 2007.

So what have those dire prognostications achieved? Probably not much more than adding to investor anxiety.

It's clear that market volatility will continue in the near term, keeping fear high. And, given all the unknowns and the shrinking investor base as baby boomers become more focused on preserving their retirement assets than generating long-term stock market returns, it's going to be a challenging investment environment for some time.

That's contributed to the $171 billion in outflows from mutual funds over the past year, per the Investment Company Institute.

But it's not necessary to give up on stocks completely. In fact, it may be best to go upstream and start some selective buying, because history has shown that when everyone predicts the end is at hand, savvy stock pickers thrive and get some of their best-ever buys.

As one of the best at the game, Warren Buffett, has said: It's best to get greedy when everyone else is afraid.

And what would get investors back into stocks en masse is a resolution to the European sovereign debt crisis and a steady continuation of what we've seen in the market so far this year. The S&P 500, now at 1,400, is up almost 13% on the year, and if it gains another 12%, it will reach its all-time reached in 2007.

That's the type of news that will silence the naysayers.

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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