The End of the New Normal

Last Updated Feb 1, 2011 10:35 AM EST

Bill Gross and Mohamed El-Erian of PIMCO are two of the most respected investment managers in the world, with PIMCO having more than $1 trillion in assets under management. When they speak, investors pay attention. Should you?

In the summer of 2009, Gross and El-Erian warned investors that they needed to be prepared for what they called the "New Normal." In a letter to investors, Gross described the New Normal as a period characterized as follows: "Growth is slower, profit margins are narrower, and asset returns are smaller than in decades past." He specifically forecast economic growth of 1-2 percent, unemployment of 7-8 percent, inflation kicking in over the next three to five years and investment returns of 4-5 percent (or "half-size returns") for the foreseeable future?

From the third quarter of 2009 through the end of 2010, the S&P 500 Index returned 41.1 percent and the MSCI US Small Cap 1750 Index returned 62.2 percent. And profit margins for U.S. companies are near record highs as a percent of GDP.

While PIMCO was forecasting very low rates of growth of the GDP, the economy grew about 2.7 percent in 2010, and the Federal Reserve Bank of Philadelphia's Survey of Professional Forecasters expects GDP growth rates of 2.5, 2.9 and 3.0 percent over the next three years. That's basically in line with the 3 percent long-term growth of the economy.

As for inflation, the CPI rose just 1.5 percent in 2010. The Philly Fed survey forecasts inflation of just 1.6 percent in 2011, 1.9 percent in 2012 and just 2.2 percent over the full decade. And the market is forecasting similarly low inflation as indicated by the breakeven inflation rate for TIPS compared to nominal bonds.

Investors scared off by the forecast of the "New Normal" certainly missed out on the great returns equity markets around the globe have provided since the gurus from PIMCO made their famous forecast.

While I have the greatest respect for both El-Erian and Gross as money managers, I have also learned to ignore their forecasts, because I believe acting on them is more likely to prove counterproductive.

Joseph Mezrich was the head of quantitative strategies group at Morgan Stanley Dean Witter when he made this observation: "Surprise is a persistently important factor in stock performance." Of course, surprises are by definition unpredictable. Yet, that doesn't stop people from making forecasts, the media from publicizing them and investors from acting on them. But that doesn't mean you have to follow in their footsteps.

The winning strategy remains the same: Have a well-developed investment plan that includes the building of a globally diversified portfolio and doesn't take more risk than you have the ability, willingness or need to take. And as long as the assumptions that went into your plan remain unchanged, stay the course. The only actions you should be taking are to rebalance and tax-loss harvest as appropriate.

More on MoneyWatch:
When Equity Markets Will Get Back to 'Normal'? Never Laszlo Birinyi's Latest Prediction Is Interesting, but Worth Nothing The Death of Buy and Hold How Did the 'Sure Things' Fare in 2010? Is Inflation Risk Overstated?
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    Larry Swedroe is a principal and director of research for the BAM Alliance. He has authored or co-authored 12 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.

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