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Bill Gross says it's time for investors to plan a "Great Escape"

March 28, 2012: 5:00 AM ET

Bill Gross

Bond king Bill Gross says it's time to get your portfolio ready for a long-period of lower market returns.

FORTUNE -- Apparently, Bill Gross picks movies as well as investments.

Bond investor Gross, who runs the world's largest mutual fund Pimco Total Return (PTTRX), is known for his quirky letters to investors. In the past he has dispensed love advice (specifically for Europe) and written about why he hates automatic flush toilets.  His letter this month, which came out on Tuesday, instead offers movie advice. Gross' big screen pick is The Great Escape.

The movie came out in 1963, is about World War II and stars Steve McQueen as the head of a group of American soldiers trapped in a German POW camp. Gross says the movie reminds him a lot of what it feels like to be an investor today. Ouch. Except it's debt that is playing the role of the Nazis. And if you don't dig a really big tunnel it's not clear you will ever afford to retire. Not encouraging stuff.

Basically, Gross' thesis is that the market, and investors, will be trapped in a low-return world for the next few years. That's because all the things that have been boosting the market for the past few decades - rising debt, low inflation, low-interest rates - are about to reverse. And as all that unwinds, particularly the leverage, Gross sees some pretty strong headwinds for the market. Growth, at least in the 15 years that I have been watching the market, has always been one of the biggest factors in determining what a stock is worth. Less so, in the future Gross says. Because growth is going to be less predictable, and slower, and interest rates and inflation will be higher, lowering the present value of those future dollars (ask your MBA friends what that means), Gross says companies will get less of a premium for what might happen in the future. Instead he thinks companies that generate earnings now, and pay dividends now will get higher valuations, which again would be a big shift.

So what does Gross suggest you do? Generally, Gross, unsurprisingly, likes bonds over stocks. Even though he says bonds on average may only produce 4% returns. But if you are going to buy stocks, Gross says stay away from so-called growth stocks, like say Apple (AAPL), and instead buy consistent dividend paying stocks, like Exxon Mobil (XOM). So go for safety. And he says the shares of companies located in nations with emerging economies like China and Brazil should do better than American or European stocks. Lastly, Gross recommends adding commodities to your portfolio that can protect you from inflation.

The problem with Gross' prediction of where the market is headed is his "Great Escape" scenario doesn't sound all that different from his so-called "new normal," a phrase Gross helped coin three years to describe where the market was headed at the time. And yet, once we got past the correction of late 2008 and early 2009, being invested in the stock market has felt nothing like being in jail. Last year, was a rocky ride. But in general the market has done pretty well in this recovery, better than the economy in general. And stocks are up pretty significantly again this year.

Yet, it is plausible to think that is all about to change, and that the market's recent bull run should be coming to the end. Gross is right to say that the things that have boosted the market for so long are about to go against us. But that doesn't mean that we have to have a prolonged period of poor market performance. Rising interest rates and rising inflation are also usually correlated with a faster growing economy, which could also be good for earnings and stocks. Stock do tend to outperform bonds and other assets in times of higher inflation. Remember the Nifty 50. That happened in the 1970s.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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