Equities Cult High Priest Malkiel Burns PIMCO’s Gross: Reducing Stocks Would Be ‘Huge Mistake’

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.”