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Commentary > The Bottom Line
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Dow 5,000: How scared should you be?
The world's most famous bond buyer thinks stocks could fall 40 percent from here.
September 6, 2002: 5:19 PM EDT
By Adam Lashinsky, CNN/Money Contributing Columnist

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PALO ALTO, Calif. (CNN/Money) - My first thought when I saw the headline "Gross Predicts Dow 5,000" was 'What's up with a famous bond-fund manager predicting where stocks are going?'

And so I had a good chuckle at the first line of Bill Gross's September investment outlook: "Okay, so what's a bond guy doing talking about the stock market again?" the PIMCO bond fund manager muses.

The answer is simple. When a software executive talks about the economy, he's selling software (shameless self-promotion: see my article in the current Fortune about Siebel Systems). When an auto executive chirps up about the environment, he's selling cars. And, yes, when Bill Gross, the most famous bond buyer in the land, talks about stocks, naturally he's selling bonds.

The bottom line of Gross's argument is easy enough to grasp. Because stocks are expensive on a historical basis, they will underperform bonds for years to come, or at least until they come way down in value, namely to around the point where the Dow stands at 5,000, the Standard & Poor's 500 index at 650 and the Nasdaq "God knows where." Friday, the Dow, S&P and Nasdaq closed at 8,427, 894 and 1,295, respectively.

Doing the math

Gross makes many detailed arguments in his bond-sale polemic, and interested investors really ought to read it carefully themselves. He largely relies on the recently published work of other stock-market intellectuals.

But the argument Gross is most enamored with is that because today's overall stock market dividend yield is so low -- about 1.7 percent -- the market is far too expensive. The yield is calculated by dividing actual dividend payments by price -- so a low yield has historically signaled rich prices.

If stock prices drop (and dividends stay the same), the yield will rise. Were the yield on the overall market to approach 5 percent, Gross argues, the value of the underlying equities would be sufficiently low.

Not coincidentally, that yield would make them competitive with bonds, and wouldn't you know, Gross doesn't see such a high dividend yield for years to come.

A few quibbles...

Bill Gross is a really smart guy, and I won't even attempt to take apart his thesis. If, after reading his comments in their entirety, you decide he's right then liquidate your stock holdings and go with the kind of balanced bond portfolio he recommends.

  graphic  Recently by Adam Lashinsky  
  
Intel: Beware the quality trap
Cisco: Above the fray
Crapped out
  

But it is worth pointing out that the dividend picture is skewed by the past several decades of dividend philosophy, namely that technology companies don't believe in paying them. Right or wrong, when Microsoft, Cisco, Dell and seven other of the 49 U.S.-listed companies with market values greater than $50 billion don't pay a dividend at all, you're comparing 2002 apples to 1920s oranges.

Another thing to keep in mind is that even Bill Gross hasn't got a feel for timing here. His prescient book "Everything You've Heard About Investing Is Wrong!: How to Profit in the Coming Post-Bull Markets," was published in 1997. The advice was great, the timing problematic. Even now he warns it is "impossible to say exactly when, if ever, this fair valuation mark of approximately Dow 5,000 will be reached."

Come to think of it, his headline-grabbing "Dow 5,000" and timing-related backpedaling sounds an awful lot like the famous "Amazon $400" price target analyst Henry Blodget issued in late 1998. Hey, wait a second, on its way to a lot less, Amazon did hit $400 a share. Makes you think, doesn't it?


Adam Lashinsky is a senior writer for Fortune magazine. Send e-mail to Adam at lashinskysbottomline@yahoo.com.

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.