Contrarian Wisdom

Within a few days after our March issue mailed last month, I arrived at work to find a letter on my desk. The author, who happens to be one of our most popular contributors, questioned a sentence in a feature story last month that said "a reversion to the mean promises average annual returns of just 5% over the next five years."

Is this canard a journalistic given, such that it can be repeated as a factual "promised" premise?

I will bet you $1,000 that the S&P 500 does better than 5% from 2002 through 2006, and I‚ll bet you $10,000 that any fund of hedge funds you choose underperforms the S&P 500 in the same period. "Hot product [hedge funds]," indeed.

Nick Murray

Even before receiving Nick‚s note, I had grown uncomfortable with the certitude with which several of our writers, myself included, accepted that low equity market returns are virtually guaranteed for most of the present decade. Among financial magazines, we have been hardly alone in expounding that viewpoint. A recent issue of Barron‚s quotes Steve Galbraith, Morgan Stanley‚s chief investment officer, as predicting, "We‚re in for a multi-year period of low returns."

There‚s little doubt that the conventional wisdom agrees with Galbraith and many others, including contributors to this magazine like Cliff Asness, Mike Martin and Harold Evensky. One should remember that exactly a decade ago, the same gloomy outlook was as prevalent as it is now. In 1993, Forbes dressed Morgan Stanley‚s Barton Biggs in a bear costume and put him on its cover urging U.S. investors to get their money out of the United States. With Bill Clinton in the White House and his neo-socialist wife manipulating the policy agenda, the time to run was now. Folks like myself, who didn‚t succumb to Forbes‚ propaganda, still assumed that the spectacular bull market of the 1980s precluded a repeat performance any time soon, like the 1990s. Shows what we all knew.

In this month‚s issue, I had the good fortune to interview the world‚s most respected scholar in finance, Bill Sharpe, professor emeritus at Stanford University, current chairman of Financial Engines and Nobel laureate. Though cautious, Sharpe himself doesn‚t buy into the prevailing gloom.

The manic investor behavior of the late 1990s clearly has led many observers to believe that this is payback time for past excesses. Sharpe isn‚t one of them. He says he is comfortable with an equity-risk premium, the amount of additional return above what an investor can get in a bank, of 5.5% to 6.5% going forward. That‚s slightly lower than it was for much of the 20th century, but not the anemic returns many are chattering about.

There‚s a bigger point here that goes beyond defining the equity-risk premium or futilely attempting to divine where stocks are headed. Advisors are learning to create portfolios that can withstand numerous types of stress tests so that clients‚ financial futures aren‚t dependent on the strong performance of any single investment vehicle, whether it‚s real estate or large-cap U.S. equities.

The dramatic decline in interest rates that started in the early 1980s has prompted advisors to look at vehicles like preferred stock, REITs and immediate annuities, a vehicle Sharpe and others believe will enjoy more widespread use. If returns are somewhat lower going forward, income will become more important.

First « 1 2 » Next