Value Added


Coaxing 5% Returns, No Matter What

Steven Goldberg

These two Pimco funds look like safe bets, whether you're a bull or a bear. Me? I'm bullish.



The stock market has performed magnificently of late. But the gurus at No-Load Fund Analyst newsletter forecast that returns for U.S. stocks over the coming five years will be in the low-to-middle single digits -- far below the long-term annualized return of just under 10%.

I don’t share the newsletter’s depressing outlook. But I take what its editors say seriously. They are smart, careful investors who’ve been publishing for 20 years. In recent years, I’ve found their asset-allocation calls more helpful than their fund picks. What’s more, the lousy returns they’re predicting are in line with what a lot of other top market strategists are saying.

To earn healthier returns in the coming years, Jeremy DeGroot, chief investment officer at No-Load Fund Analyst, is most excited about a handful of unconventional bond funds. But don’t expect them to return 10% a year, either.

The folks at NLFA are long-term investors who don’t try to time the markets or make drastic changes to their recommended asset allocations. They tend to adjust those allocations on the margin based on their assessment of economic conditions and valuations of different asset classes.

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DeGroot and his colleagues forecast grim returns for virtually every part of the stock market. “We don’t think this is a typical recession cycle,” he says. “Recoveries from financial crises, such as this one, tend to be worse than average recoveries.”

DeGroot says stocks face several other headwinds that should lead to below-par returns over the next few years. These include:

Consumer spending will recover slowly because individuals need to rebuild their savings and because of the negative “wealth effect” caused by the decline in home prices and stock prices, which are generally still below their 2007 highs.

The growth of corporate earnings is likely to remain subdued over the next five years. Stubbornly high unemployment, huge government budget deficits and increased taxes will all retard earnings growth.

Price-earnings ratios are already above their long-term average.

For all of those reasons, No-Load Fund Analyst’s balanced portfolio currently recommends investing just 23.5% of assets in stocks of large U.S. companies. That compares with a normal weighting of 40%. The letter recommends placing just 3% of assets in stocks of small U.S. companies, compared with a normal position of 8%.

The editors have even sold their emerging-markets stock funds because they no longer believe the potential returns justify the risks.

Buy unconventional bond funds

Where do you look to earn more than 4% annualized -- the newsletter’s estimate of how much stocks are most likely to return over the next five years?

DeGroot and company see promise in a handful of unconventional bond funds. These include Pimco Unconstrained Bond D (symbol PUBDX), a fund that, as its name suggests, gives its manager a tremendous amount of flexibility (link to column about this fund). They also like emerging-markets bond funds, especially Pimco Emerging Local Bond D (PLBDX) (see A Safer Way to Invest in Emerging Markets).

I’ve reluctantly come to agree with Pimco founder Bill Gross’s forecast of a “new normal” -- the notion that economic growth and stock-market returns will be depressed for the next several years.

But I don’t think it will take as long as five years for the U.S. to fully recover from the Great Recession. I’m particularly upbeat about large-company growth stocks, both in the U.S. and in developed foreign countries. In a slow-growth environment, I think the market will put a premium price tag on the stocks of companies that generate healthy earnings growth.

Nor do I think that the superior performance of emerging-markets stocks will end. Emerging markets ought to continue to provide returns that are well above average for years to come -- albeit with occasional big stumbles along the way.

The cataclysm in stocks that ended last March reminds me more than a little of the brutal 1973–74 bear market. Stocks set their low in late 1974. The market experienced relatively short bull markets and bear markets for years afterward. But the overall direction of the market was up.

Given two or three years of positive, though subpar, economic growth, I believe there’s every chance the global economy will begin firing on all cylinders again. Once that happens, I think the likelihood is strong that stocks will begin a prolonged bull market.

I don’t know whether those happy days will begin in 2011 or 2014, but I do know this: Investors who have bet against stocks over the long term have always regretted it.

Steven T. Goldberg is an investment adviser.



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