PIMCO Chairman Bill Gross launched a bond investor’s jihad two weeks ago with his controversial remarks that the “cult of equities is dying;” now along comes the equity cult’s high priest Burton Malkiel, intoning that predictions of its demise are premature.
Malkiel (left), the Princeton economist best known as the author of A Random Walk Down Wall Street, now in its 12th edition, took to the op-ed pages of the Wall Street Journal on Tuesday, saying investors who would “pull their money out of the stock market today to invest in bonds are making a huge mistake.”
More than just tempering Gross’s anti-equity remarks, the longtime advocate of buying and holding equity-based index funds and ETFs went so far as to say that “equities today are more attractive relative to bonds than at any other time in history.”
Take that, Gross!
The market efficiency proponent cited near-zero rates as a key support for his argument. Since inflation is the foreseeable result of developed nations “saddled with large indebtedness relative to income (i.e., GDP) and large fiscal deficits,” today’s paltry yields are bound to generate negative real return, Malkiel argued.
Gross’s argument about the stock market, which in his characteristic bombast he referred to as a “Ponzi scheme,” took a completely opposite stance.
In his letter to shareholders, the bond manager assailed the so-called Siegel constant—the equity cult’s holy writ that investors taking the risk of equities will be rewarded with a 6.6% real annual return on their investment over time.
Gross called the rate of return, discovered by Wharton professor Jeremy Siegel, a “historical freak, a mutation likely never to be seen again” in a “New Normal economy” in which GDP growth is “slowing significantly.”
Malkiel, for his part, acknowledged the many uncertainties (such as eurozone woes and the U.S. “fiscal cliff”) that spook investors, but said uncertainty is always present in markets. The biggest problem plaguing markets, he said, “is the fear that our markets are not working properly.”
Malkiel argued that recent problems related to high-frequency trading actually show that markets do work. Knight Capital’s recent computer mishap yielded an advantage to other market makers and investors to buy its mispriced sell orders, while Knight was punished by the market with a huge loss in market cap. In other words, the market quickly took care of inefficiencies and the extreme volatility did nothing to harm long-term retirement investors.
"The markets punished Knight far more severely than regulators ever could," Malkiel wrote. "That's exactly what the capitalist system is designed to do."
The Princeton professor thus concludes: “The only hope—both for individuals and for institutions running retirement portfolios—is to increase, not decrease, the share of the portfolio devoted to equities.”