Baby boomers prefer bonds over equity

Sixty years in the making, the “cult” of stocks may have finally died, according to Citigroup’s global equity strategist, killed by baby boomers preference for bonds and a lost decade of zero returns.

"Having two 50 percent bear markets in one decade is enough to test the patience of the most determined equity cultist,” said Citigroup’s Robert Buckland, in a note to clients. “Just as strong returns helped to build the cult of the equity in the 1950s, so weak returns are tearing it down now.

"U.S. pension funds allocated just 17 percent to equities in 1952, according to Citigroup. By 2006, those same funds were putting 69 percent in stocks and just 18 percent into fixed income. Buckland said that equity holdings may not revert back to those miniscule levels, but the reversion that began in 2006 could continue for quite a long while.

"Populations would seem to favor bonds over equities — most "lifestyle” pension schemes automatically switch equities into bonds as a worker approaches retirement age," said the strategist.

The S&P 500 fell almost five percent in August, for its worst performance during that normally quiet month in nearly a decade. The index is still well above its 12-year low of 666 reached last year during the depths of the credit crisis, but that is because of new money from institutions like hedge funds. Retail investors have poured money into bonds even as stocks have mounted this comeback.

"This is your historical response to a secular bear market that began in 2000 as we go through the five stages of acceptance,” said Peter Boockvar, chief equity strategist at Miller Tabak. “We are entering a dangerous phase where there will be no difference between a 10 price-earnings ratio and a 15 P-E. That could be the difference between an S&P 500 that goes to 800 instead of 1200 without any major change in the fundamentals."

Buckland, who has declared the “cult of equities” already dead in Japan and Europe, lays out in the report reasons why the worship of stocks began in the first place. Reasons he cites are the application of Modern Portfolio Theory, a long run of peace and prosperity and, most of all, a self-fulfilling cycle sparked by the great returns of equities relative to bonds in the 1950s.

"It took many years for the wounds of the 1929 crash to heal as U.S. equities only managed to regain their pre-1929 crash levels in 1954,” wrote Buckland. “Pension funds bought more and more equities because they kept outperforming. Insurance companies (except in the US, where their exposure to equities has been limited by law) and retail investors couldn’t resist the same trade."

While it may seem odd for a global equity strategist to declare the death of the market he covers, Buckland says there are still plenty of money-making opportunities for emerging market stocks, as well as for select strategies deployed within the dead stock markets. For example, buy companies with access to the incredibly cheap financing in the corporate bond market that they will use to finance share buybacks. Also smaller companies that could be purchased by mega-caps will outperform.

Both these trends have begun to unfold in the market. Hewlett-Packard embodies them both, having announced a $20 billion buyback and a raised bid for data storage play 3-Par during this week alone.

While Buckland stops short of fully declaring the death of the U.S. stock market, he is not alone among high profile Wall Street figures in voicing their frustrations with the trading environment of the last decade. Hedge Fund legend Stanley Druckenmiller decided to close his fund last month after thirty successful years, citing the vicious downturns in the market taking a "cumulative toll."

Buckland’s report did remind traders of the infamous BusinessWeek cover story with the headline "The Death of Equities” that ran in August of 1979, just before a two-decade long revival in stocks.

The Citigroup report “is the most bullish thing I have seen in a while," said Michael Block of Phoenix Partners Group, who still believes Buckland is a “great” strategist. “We’re clearly not out of the woods, but equities are not dead. It sounds like a guy frustrated with his models because cheap valuations are not getting recognized."

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