"Oh, you're meeting with Jeremy Siegel tomorrow? Lucky you," a professor at the University of Pennsylvania's Wharton School told me. "You'll leave feeling much better about your investments than when you entered," he said with a laugh and a hint of sarcasm.
This is the Jeremy Siegel -- Wharton's famed finance professor -- the public has come to know: A perennially bullish academic who was born an optimist and never looked back, leading to criticism that he's more stock market cheerleader than rational analyst.
But after meeting with Siegel at a conference at Wharton in Philadelphia this week, I left with a different view. He is perhaps as bullish on the stock market as he's ever been. "The pessimism these days is just striking," he notes. And some of his arguments are still as controversial, if not logically curious, as ever. But agree with him or not, Jeremy Siegel's view on the stock market is fascinating. There's a reason people still pay attention to him.
Siegel is quick to note that being characterized as a permabull is undeserved. "People ask me, 'Jeremy, why are you always so bullish?' Well, I'm not. I wasn't bullish on stocks in 2000," he says. And he's right: In March 2000, Siegel penned an op-ed in The Wall Street Journal warning that technology stocks were grossly overvalued.
But it's his book, Stocks for the Long Run, that people remember. First published in 1994 and now in its fourth edition, the book has sold hundreds of thousands of copies. Its message is clear: Over time, stocks outperform all other assets classes. They are, definitively, the greatest wealth-generating machine that investors can get their hands on. Hitting the shelves just as one of the largest bull markets in history was heating up, the book served as a bible during the 1990s for investors anchored to the idea that stocks could go only one way -- up. After stocks crashed and then languished for the past decade, Siegel has been the butt of all kinds of criticism. As markets bottomed in early 2009, Business Insider wrote, "No, the charming Wharton professor isn't dead. But he may just have killed what's left of his reputation." It continued: Siegel "has been very bullish, and very wrong, for the past two years."
But perpetual bullishness isn't what Siegel preaches. Most of those criticizing his bullishness ignore the title of his book. He isn't just bullish on stocks; he's bullish on stocks in the long run. I'd even qualify that: Siegel is bullish on stocks in the long, long run.
A group of financial writers had been at Wharton for four days, listening to lectures on behavioral finance, outsourcing, and accounting fraud. Siegel's presentation had a feel different from all others. He isn't just a professor presenting his research. He's a seasoned (he's been a professor for 40 years) financial philosopher meets historian meets talented showman. The last part is perhaps Siegel's most underappreciated strength. The man is far more charismatic than you might think. When presenting otherwise dry data on historic investment returns, Siegel drops his voice to a whisper and then booms into a punch line for dramatic effect.
It's that data that underscores Siegel's view of the market. In the late 1980s, then a monetary policy economist, he began collecting historic returns on stocks, bonds, cash, and gold going back to 1802. It's the most complete set of historic investment returns available, he points out.
What the data show is crystal clear. One dollar invested in stocks in 1802 would be worth more than $700,000 today, adjusted for inflation. The same dollar in bonds would be worth less than $1,500. In gold, it's about $4. In a dollar kept under your mattress, it's $0.05. Over two centuries, there is no substitute to stocks.
Which would be an open-and-shut finding if we were Methuselah, and had 200 years to save. Unfortunately, we don't. And within that 200 years of data sits an uncountable number of chaotic swings, with stocks moving from wild bull markets to crushing bear markets -- even a 90% collapse during the Great Depression. Over some periods, stocks dramatically underperform bonds, gold, and cash. That holds true for the past 10 years, as investors know all too well.
But it's at this point -- the point where so many become skeptical of Siegel -- where his work becomes the most persuasive. Comparing risk between stocks and bonds, the opposite of what most assume is true emerges when measured over long periods of time.
Modern finance theory holds that stocks should return more than bonds because they're riskier. What Siegel's data show, however, is that this risk diminishes, even flips upside down, when you hold an asset long enough. Since 1802, average stock volatility is much higher than for bonds when looking at one-, two-, or five-year periods. But then it flips. When held for 10 years, average real stock returns become less risky than bonds. Over 20-year and 30-year periods, there's no comparison: The upside potential is far greater for stocks, and even the worst periods generate positive real returns, while the worst period for bonds leaves investors with substantial real losses. "Even when looking at periods that ended in the bottom of the Great Depression, stocks had a positive real return if held for 20 years," Siegel said. "You have never lost money in stocks over any 20-year period, but you have wiped out half your portfolio in bonds. So which is the riskier asset?" he asks, his voice now booming. "And nothing that's happened over the past 10 years negates this data." Nor are these unreasonable periods of time. Twenty or 30 years is about the average time between when people start saving and when they retire.
This is where those criticizing Jeremy Siegel often get it wrong. The key to understanding his analysis is that he's only concerned with long, long periods of time. Asked about stocks' recent lost decade, he notes that average annual returns since 1991 have actually been quite good. Ten-year periods aren't of much interest to him. They're too short.
"Stocks go back and forth, back and forth," he says. "The past decade has been frustrating. But that's only because we had unreasonably high returns in the 1990s. The last 10 years has just offset the previous decade."
Siegel is especially bullish on stocks today because he thinks valuations are extraordinarily low. Stocks now trade at a price-to-earnings ratio of 11.5, compared with a historic average of closer to 19 when interest rates are this low. Analysts expect the S&P 500 to earn $112 next year, putting stocks at just over 10 times forward earnings.
Now, most investors think the $112 figure is far too high, and will come down -- a reason many use to justify being bearish on stocks. Siegel actually agrees. "I don't believe the number. I think it will come down," he says. But that's fine. Even if earnings fall 25% from current levels, stocks would still sell at a P/E ratio close to their long-term average. If earnings stay at current levels forever, stocks would still be a great buy, Siegel says. "You don't need growth to justify these numbers," he says. "And if we actually earn $112 next year? Oh, god. It's a bonus. You'll see stocks up 30% or 40%."
The amount of pessimism in today's market is totally overdone, he says. "It's one of the most bearish forecasts I've ever seen." Bond giant PIMCO has a gloomy theory called the "new normal," which forecasts real economic growth of 1%-2% going forward, compared with 3%-4% in the past. At the same time, gauges of economic growth expectations, such as the yield on Treasury inflation-protected securities, or TIPS, are now near zero percent. The market panic of the past few months has made even bearish analysts like PIMCO look cheery. "It's the ultimate sign of pessimism," he says.
What keeps Siegel bullish on the long term is a belief that what drives our economy over time is still alive and well. In the short run, economists focus on demand as the key economic driver. In the long run, the real fuel is productivity, or output per hour worked, and population growth. This is one of the least controversial theories in economics, but it, too, is prone to criticism when viewed over different time periods. Most economists are bearish on the economy right now because demand is low as consumers deleverage. Siegel agrees, but remains bullish on the long run for a simple reason: Productivity is not only increasing, but it's increasing at an accelerating rate as technology connects the world. When ideas build on top of other ideas, prosperity multiplies. "We've brought 2 or 3 billion people online sharing ideas," Siegel says. The impact that this has is astounding. People used to work full time just to feed and shelter themselves, he notes. Today, the average person in the developed world needs to work just an hour a day to support basic human needs. Productivity has dramatically increased the quality of life around the world, and there's little sign of it slowing down -- in the long run.
Still, there are legitimate critiques of Siegel's views that remain open to debate. Yale economist Robert Shiller -- a good friend and former classmate of Siegel's -- values stocks based on an average of the past 10 years' earnings, adjusted for inflation. He calls it the cyclically adjusted price-earnings ratio, or CAPE. Based on CAPE, stocks are currently fairly valued at best, if not overvalued.
Asked to defend his analysis against CAPE, Siegel's views turn fuzzy. "CAPE shows valuations to be quite high, but the source is purely the earnings collapse of 2008-2009, when financials had these enormous write-offs," that aren't indicative of corporate America's earnings power, he says. When I point out that Shiller and others (including our own Alex Dumortier) have shown that this isn't so clear -- even ignoring the earnings collapse of 2008-2009, CAPE doesn't move significantly, which is the point of using a 10-year average -- Siegel doesn't come up with much of a response, noting that the losses were spread out over several quarters.
He is equally incredulous of the idea that corporate profits are at a cyclical top as profit margins approach record highs. "Those profit margins are up because foreign sales make up a larger percentage of companies' business. And guess what? Foreign business generates higher profit margins because they have lower tax rates," he says, although foreign sales as a percentage of total S&P sales have actually declined since 2008. "Some say we're at the top of this boom. I just don't understand that. Have you looked around? What boom are they talking about? The recession just ended two years ago. Unemployment is still high. How can cyclically adjusted profits be at a cyclical high?"
He then says something that catches my attention: "Forget the numbers. Go back to the logic of it all," he says. This was an interesting turn. The same Siegel who an hour earlier asked us to ignore our feelings about stocks and look at the data was now asking us to ignore the data and look at our feelings.
It is moments like this, I believe, that causes Siegel to face criticism. His work is valuable, persuasive, and intriguing. But it's very specific to the long run. Those critical of his work often ignore this, and it appears Siegel may forget it at times, too. The truth is, short-term profit peaks or 10-year earnings multiples aren't that relevant to his findings. Almost any critique thrown at Siegel can be properly defended with the words, "That shouldn't matter to investors with a long-term time horizon." Ironically, the beauty of Siegel's work is the idea that the short-term market fluctuations his critics obsess over set the stage for the long-term returns he emphasizes. "Fluctuations unnerve investors," he says. "Why? Because people can't stand them in the short run. Volatility scares enough people out of the market to generate superior returns for those who stay in." In that sense, those critical of Siegel's work are often actively proving its validity.
What might change Siegel's mind? Another uncontrolled collapse of the financial system, similar to what happened in 2008, could set the global economy back in a big way.
Will that happen, someone asks?
"Stay tuned," he says.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
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