Note to Bond King: Check Your Math

Seth J. Masters

The Wall Street Journal published an article on August 1 headlined: “Bill Gross: Equities are Dead.” In fairness to Gross, what he actually wrote in his August “Investment Outlook” was, “the cult of equities is dying.” We agree with most of Gross’s argument—but not with his unsupported forecast of extremely low  stock returns.

Let’s take a look at Gross’s claims:

1) Gross notes that bonds have outperformed stocks for the last 10, 20 and 30 years. With long US Treasuries currently yielding 2.7%, it is unlikely that bonds will replicate the performance of decades past.

We agree. That is why stocks are attractive today relative to bonds. Bonds—having outperformed—are now unusually expensive and have low expected returns going forward. By contrast, stocks—having performed poorly—are cheaper than normal and are likely to significantly outperform bonds over the next 10 years.

2) Gross argues that US stocks can’t maintain their 6.6% average annualized real return over the last 100 years. The 6.6% real equity return was 3% higher than real GDP growth, with shareholders gaining at the expense of labor and government. Labor and government must demand some recompense for wealth creation, and GDP growth itself must slow due to deleveraging.

We agree. We are now in a lower return environment. The question is, how low? Let’s concede that stocks will grow in line with real GDP. Over the long haul, real GDP growth primarily reflects population (growing a little over 1%) and productivity (growing just above 2%). That would give us a projected real equity return of maybe 3%—less than half the historical 6.6% rate.

3) Gross asserts that stocks will have a nominal return of 4%.

This is where Gross’s math gets fuzzy. Why this sudden switch to nominal instead of real returns? Does Gross expect that US population will shrink, productivity gains will disappear, and inflation will remain quiescent forever? That is what needs to happen for long-term nominal GDP growth to be as low as 4%. The scenario is possible, but hardly likely. Just assuming that inflation runs at a relatively tame 3% with below-normal real GDP growth of another 3%, we’d have nominal equity returns of 6% or so. That looks quite attractive when you get just 2.7% for holding long bonds to maturity.

In our recently published paper “The Case for the 20,000 Dow,” we show that with reasonable assumptions we can get returns in the 6% to 7% range and that the Dow hits that target in five to 10 years. We will also lay out our argument in an upcoming blog post.

Most investors today are very concerned about equity volatility, and for good reason. But there is another risk that should concern investors: the risk that their investments will not keep up with inflation and meet their goals. As investors balance short-term market risk against the long-run risk of falling short of their objectives, we think an appropriate allocation to equities continues to improve the likelihood for success.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Seth J. Masters is Chief Investment Officer of Asset Allocation and Defined Contribution Investments at AllianceBernstein and Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein.


  1. “Does Gross expect that US population will shrink, productivity gains will disappear, and inflation will remain quiescent forever? That is what needs to happen for long-term nominal GDP growth to be as low as 4%.”

    No, that”s not really what needs to happen.

    US population does not have to shrink at all, rather only that it grow less than the “little over 1%” figure indicated.

    US annual population growth rates have generally been below 1% since the early 70s (but for a brief & unsustained surge in the early 90s), and the historical population growth rate trend has clearly been trending downward in the US for over a century now (was nearly 2% around the turn of the last century, and has been in the lower 0.9% for the most recent decade+). During the Great Depression (the last time we went through a Fisherian debt-deflation following a Minsky-ian financial crisis), population growth rates fell from “a little over 1%” to the 0.6% range. Add to the mix the right”s antagonism towards immigration, and it not at all difficult to conceive of relatively lower population growth that the ”norm” suggested by Seth.

    Ditto re: productivity gains: Productivity does not have to actually reverse into negative territory (although that has happened for brief periods of time), rather the rate of productivity gains merely has to slow from the assumed 2% rate, which is entirely reasonable (see, e.g.,

    Over the course of the “Great Moderation” [which is now long gone & replaced by the ''new normal'' of delevering our way out of a balance sheet recession] nonfarm business sector prductivity trended from approx. 1.1% during the 1973~1979 stagflation era steadily upward to 2.5% for the 2001-2007 period of the Bush policy area… only to start falling again (1.8% average for the post-bubble era). Without a clear path out of our current debt-deflation induced economic malaise, it is hard to see how 2%+ productivity gains can be sustained over the next decade in the face of dampened aggregate demand & ongoing deleveraging… unless corporate America resorts to yet more unemployment. It is not all that hard to envision an extended period of low productivity gains of, say, only 1%, as has happened for multi-year steches over the last 40 years.

    As for inflation: Maybe not ”forever”, but perhaps for the next 10 years. Until the private sector”s balance sheets are sufficiently repaired – which then allows aggregate demand to rebound sufficiently to start making a run towards full employment & full use of productive capacity – it is unlikely that inflation is going to consistently generate even your ”modest” 3% target. The Fed has already set a 2% inflation target – which it has barely met even in the face of energy price spikes & a domestic drought”s impact on agricultural commodities – through 2014 ~ 2015. With Europe on its knees, unemployment stubbornly high & capacity utilization stubbornly low, and the US dollar still the reserve currency of choice, there is little if any inflationary pressure anywhere, that I can see.

    So, at the end of the day, all that is needed to see 4% nominal equity returns is, let”s say (just for the sake of argument), 0.7% population growth + 0.7% productivity growth, then real stock returns are a measly 1.4%. What is unreasonable with that? A bit pessimistic, perhaps, but certainly not unreasonable.

    Add back the Fed”s targeted 2% rate and you get 3.4% nominal equity returns… below Gross” estimate, without much stretch of the imagination at all. And without population shrinkage or productivity collapses of any sort.

    • seth masters

      Your scenario is possible, but it’s just one scenario, and not the most likely one, in our view. In any case, even 3.4% nominal equity returns would beat prospective long bond returns. You’d still get to Dow 20,000, but it would take longer. In my next blog post, I will discuss a number of different scenarios and how long it would take the Dow to reach 20,000

  2. Rank Dawson

    Can I get a copy of the DOW 20,000 report?

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