Bill Gross Says Transgenerational Stock Market Outlook Does Not Favor Equities Rebound

Bill Pimco, the manager of the largest bond fund in the world, posted an article last month entitled Dow 5,000 Redux that I think captures the essence of what has happened in the market. He's the first to admit that his analysis of stock markets are often wrong but I still think his central observation is trenchant.

First, he looked at traditional market valuations such as Q rations and PE ratios to determine if the market was cheap. The Q ration is a measure of the value of the stock market relative to its replacement cost. Or, in plain English, the value of stocks relative to the value of simply reproducing the companies versus buying them. The market should always be over 1 otherwise it wouldn't make sense to buy stocks. Just recreate the companies for yourself. The Q ratio has almost never been lower, implying that the market is severaly undervalued.

The same thing holds true for the PE ration, which measures a stock's price versus its earnings. According to PE ratios the stock market is also massively undervalued.

So, if that's the case, why isn't everyone going out and buying stocks at a discount?

Because the times have changed and comparing these rations pre-credit crash to post credit crash is like comparing apples to oranges. As I've discussed before, the credit crunch and banking crisis is not a temporary downturn, but rather the end of a model that was built massive liquidity, debt, and overleverage (related article: Financial Companies Face $1.2 Trillion Risk).

Gross echoes this saying:

"My transgenerational stock market outlook is this: stocks are cheap when valued within the context of a financed-based economy once dominated by leverage, cheap financing, and even lower corporate tax rates. That world, however, is in our past not our future. More regulation, lower leverage, higher taxes, and a lack of entrepreneurial testosterone are what we must get used to – that and a government checkbook that allows for healing, but crowds the private sector into an awkward and less productive corner."

What does this mean for stocks? The firepower that once propelled the Dow to 14,000 is gone. The massive liquidity that drove leveraged profits is gone. Mergers and buyouts fueled by flush private equity companies are gone. In its place will be a slower, perhaps more stable pace of growth and profits. Slower growth means lower PEs. Lower PEs mean lower stock prices.

The massive bull run that started in the 1980s is over and the 14,000 Dow will look as high as Himalaya for quite some time, or at least as high as Nasdaq 5000.

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