At the height of the dot-com era, with the Nasdaq trading at 5,000, the airwaves were filled with predictions of even bigger gains to come. One prediction that called for "Dow 36,000" was a sure sign that stocks were headed for trouble. Bubbles get pricked right at the time of maximum confidence in future gains.
Of course, it works the other way as well. Stocks have delivered very little for investors since 2000, and according to some polls, more than 80% of individuals simply don't trust stocks. Even some of the pros are getting pessimistic on the long-term viability of stocks. Bill Gross, the well-respected head of Pacific Investment Management Co. (PIMCO), has been making the rounds, emphatically declaring that stocks are dead and that you need to prepare for zero gains in the years ahead.
You can read about Gross' comments in this Op-Ed piece he penned for The Wall Street Journal.
In a nutshell, Gross argues that if the economy is only going to grow at a tepid pace in the years ahead, then there's no way that stocks can continue to achieve the 6.6% historical gains we've seen. In effect, he's suggesting that stocks are likely overvalued simply because they have been rising faster than the gross domestic product (GDP) has grown over the past 30 years.
Put simply, I think Gross is dead wrong. Here's why…
If you read the Op-Ed, then you might spot some flawed assumptions, and I'm surprised Gross is overlooking them. The biggest flaw: Gross is equating economic growth with the No. 1 driver of stock prices: profit growth. Simply put, 2% GDP growth does not equal 2% profit growth.
Companies have been operating in the context of 0% to 4% GDP growth every year for the past three decades. Yet in most years, companies have seen sales and profits rise at a faster pace, perhaps two or three times the rate of economic growth.
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