Coping with Lower Long-Term Stock Market Returns

Much of Bill Gross’s latest monthly essay is devoted to a eulogy for his recently-deceased pet cat. After this touching section is the meat of the essay. Gross states that returns from assets (all assets, not only stocks) are likely to be lower in the relevant future than they have been over the course of his career. Investors have to decide what they’re going to do about that. Gross offers a couple of possible strategies and clearly favors one of them. Other possibilities are to add different asset classes to your portfolio and make your strategy more tactical, buying assets when they are down and selling them after generate some strong returns.

But on one of those thin pages the prospective author should introduce the caveat that the past 15 or even 30 years have been a rather remarkably short and non-volatile period of time, and future Sharpe ratios or other measures of risk/return may not exceed Treasury Bills in the same amount as before. A rather familiar graph of 10-year Treasury yields as shown in Chart 2 would hint at this. What I hope the reader will note is not only the dramatic decline in yields since the early 1990’s but the relative linear (non-volatile) path that they followed. Granted, for other asset classes such as stocks, there was 1987 and the aforementioned dotcoms and subprimes, but the linear path is clear: higher asset prices over long periods of time generated in part by the steady decline of 10-year Treasury yields to a 2012 bottom of 1.39%. A Bull Market almost guarantees good looking Sharpe ratios and makes risk takers compared to their indices (or Treasury Bills) look good as well. The lesson to be learned from this longer-term history is that risk was rewarded even when volatility or sleepless nights were factored into the equation. But that was then, and now is now.