by Jeff Sommer
After the last several years, you don’t need a finance course to know that stocks are risky.
If you’ve looked at the fluctuating value of your own stock portfolio, you already have a visceral understanding of market volatility. These violent ups and downs provide powerful reasons for fleeing stocks - and for buying protection in the form of government bonds, even if their yield is minuscule.
Investors may have absorbed the arguments for avoiding risk so completely that they have lost their taste for it. That’s why a new position paper by Seth J. Masters, chief investment officer of Bernstein Global Wealth Management, is startling. Its title is “The Case for the 20,000 Dow.”
On Friday, the Dow closed below 12,900. Mr. Masters says it’s time to consider the chances that the Dow will rise by more than 7,000 points - an increase of more than 50 percent. He says the odds of that happening by the end of this decade are excellent.
For long-term investors right now, he says, stocks are a much better bet than bonds. “This argument may seem provocative,” he said in an interview. “But that’s only because market conditions are so unusual, and so many people have become so pessimistic.”
That pessimism is grounded in recent history, he acknowledged. The stock market is extremely volatile now, and stocks are being battered for all kinds of reasons. Take your pick. At the moment, major banks are being investigated for rigging interest rates. In the United States, the economy has hit a soft patch, and in a nasty election season the government is heading toward the so-called fiscal cliff, with spending cuts and tax increases set to take effect automatically at the end of the year.
In much of Europe, the economy has been contracting, and the finances and governance of the euro zone are unstable. On top of all this, in crucial emerging markets like Brazil and China, economic growth is slower than had been expected. And that is just a partial list of the factors weighing on the market. Quite often, stocks have been sinking for no apparent reason at all.
Even so, stocks over the next decade may be less risky, in some respects, than the supposedly safe market for United States Treasuries, Mr. Masters said. His underlying argument is that the world has faced dire conditions before, and markets and economies have bounced back.
“People are acting as though the world is going to end,” he said. “It might end, but we think it won’t, and we think that’s no way to live your life.”
Precisely because bonds are now extraordinarily overvalued and stocks are undervalued, in his view, stocks are extremely likely to outperform bonds over the next decade or two. The Dow Jones industrial average is likely to reach 20,000 during that time - and probably within the next five to 10 years, he said.
“Our projected stock returns may sound optimistic,” he writes. “They’re not. They are well below the long-term average for U.S. and global equities and based on conservative assumptions about economic and market conditions. Bonds, on the other hand, are unlikely to outpace inflation, because current yields are extremely low.”
Bernstein projects 8 percent median annual returns for a diversified portfolio of global and domestic stocks over the next 10 years, versus 2 percent for 10-year Treasuries. At that rate for stocks, “the Dow could hit 20,000 in five to 10 years,” Mr. Masters continues. “In the same time frame, the S.& P. 500, a more representative index, could hit 2,000.”
Annual stock market returns of 8 percent were, until recently, commonplace. At the moment, he concedes, they are not. And, in an interview, he said he was not predicting that stocks would actually rise 8 percent next year or in any given year but instead was presenting a “range of probabilities” for investment returns. “We don’t know where stocks will go,” he said. “And right now they are likely to be extremely volatile, which could feel very unpleasant.”
Buffering that volatility makes sense for risk-averse investors, he says. Over the short run, for example, a portfolio that would typically contain 60 percent stocks and 40 percent bonds as a strategic allocation should be ratcheted down to 54 percent stocks and 46 percent bonds. That should reduce portfolio fluctuations. Eventually, though, he says, such a portfolio should return to a more typical stock allocation.
Over 10-year periods since 1900, stocks have outperformed bonds 75 percent of the time, according to Bernstein’s calculations. But today, bond prices are relatively high - their yields, which move in the opposite direction, are extraordinarily low - and stock prices are relatively low. So the firm sees the chance of stocks beating bonds over the next 10 years at 88 percent.
Stocks have been cruel and it is hard to love them now. Still, Mr. Masters writes, “We think that 10 years from now, investors will wish they had stayed in stocks - or added to them.”
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