Bulls Will Have Their Day The next age of equities is coming. By Barton Biggs | NEWSWEEK Published Jul 11, 2009 >From the magazine issue dated Jul 20, 2009
At a recent dinner this writer attended with the glitterati of some of the world's major investment institutions, about half the group believed that over the next couple of years stock markets would set new lows below those of early March. Almost everyone agreed it would be a long time before a new global bull market emerged in the U.S. or the rest of the world. Instead, markets would trade within a broad, painfully low range similar to the one that prevailed from 1966 to 1982, when the Dow Jones Industrial Average wandered aimlessly between 500 and 1000. Considering all the financial and economic problems the world faces, it's hard to disagree, but I do. As the wine flowed and tongues flapped, a consensus emerged that economic growth in the developed economies would be a paltry 1 to 2 percent a year and that the annual returns from stocks in the U.S., Europe, and Japan over the next five years would be in the midsingle digits at best. There were some who argued that the emerging markets would provide faster growth and richer returnsperhaps around 10 percent per yearbut the skeptics maintained this was unrealistic if the S&P 500 delivers only 4 percent to 6 percent. Too many of the developing economies are too dependent on exports to the big developed economies. But there is another forecast worth considering, though it might sound Pollyanna-ish. It goes like this. The major stock markets around the world have just been through one of the most dismal 5-, 10-, and 20-year periods in history, both compared to bonds and also in real (inflation-adjusted) terms. Let's take the U.S. as an example. For the past five years, through the end of the first quarter of 2009, the 10-year Treasury bond had a total return of 6.2 percent a year, while the S&P 500 declined by 4.8 percent a year. For the last 10 years, the returns are also drastically in favor of bonds, which are up 6.8 percent, while stocks are down 3 percent. Bonds have now beaten stocks for 20 and 30 years, too. The rewards have been poison for stocks, worldwide. In most major markets, equities have had negative real or inflation-adjusted returns for the past 10 years. In the U.S. the S&P 500, adjusted for inflation, is down more than 50 percent from the level of 10 years ago, and even more from the highs of 2000. By contrast, bonds have had a small, positive real return over the past decade. In other words, it has been much better over the past three decades to be a lender rather than an owner! This is not the way the world is supposed to work. Entrepreneurial capitalism cannot continue if it does. Way back in 1831, Alexis de Tocqueville wrote that what made America great was its democratic institutions and the entrepreneurial spirit of its people. The rewards to the high-quality fixed-income investor cannot indefinitely exceed those earned by the risk-taking owner. Equity investing is the wellspring of economic growth, and in the long run, it has to generate positive real returns and real returns that are significantly higher than those of bonds. Indeed, in the U.S. over the 20th century, stocks had a real return of 6.9 percent a year versus 1.5 percent for bonds. The same relationship is true in other countries. Over the long run, stocks in the U.K., Canada, and most European countries also have returned around 5 percent a year more than Treasury bonds, and in Australia, Germany, and Japan, the -premium earned over bonds has been around 7 percent. For raw returns, the three best stock markets in the 20th -century were Sweden, Australia, and the U.S., in that order. When stocks do poorly versus bonds and inflation, it has always been a great buying opportunity. It has only happened twice before in America: in the second quarter of 1932, and the third quarter of 1949. Things looked pretty grim back then, tooin Q2 of 1932, you had the Depression, financial scandals, and the rise of Hilter. In 1949, investors expected a postwar slump, tax rates were sky-high, and communism loomed on the horizon. In both cases, the next five years saw a violent bull market in the S&P 500, which outperformed bonds by more than 20 percent. The lesson of history is clear. The world has just seen one of the greatest bull markets in government bonds ever, accompanied by massive leveraging of the financial system and the bursting of the technology and housing bubbles, climaxing in the most severe recession since the 1930s. A brutal bear market has left stocks cheap in Europe and Japan, slightly undervalued in the U.S., and fairly priced in emerging markets. Now, heavy stimulus programs will result, inevitably, in higher inflation, which will crush government bond prices. All of this means that over the next five years stocks are the place to be. It's good to be an owner again. Remember buy low (stocks), sell high (bonds).
