To Jeremy J. Siegel, it's still a great time to be in the stock market. "The shocks of the recent past shouldn't alter investors' belief in the future," he says.
LONG before he began studying economics, Jeremy J. Siegel charted the ups and downs of the Dow Jones industrial average on the walls of his childhood bedroom. That fascination with stocks has never ebbed.
Now a professor of finance at the Wharton School of the University of Pennsylvania, Mr. Siegel, 64, knows that not everyone shares this passion — but says he believes that nearly everyone should invest in the stock market and keep their money there as long as they can.
That was the theme of his influential book, “Stocks for the Long Run,” first published in 1994 and now in its fourth edition. Have the unsettled markets of the last few years softened his view? “Not at all,” he said.
In fact, in several phone conversations, he said that this is a great moment to be an investor. “It’s exactly times like this, when bearish sentiment has brought down valuations, that your chance of strong returns in the following years is greatest.”
Professor Siegel emphatically rejected the warnings of extreme bears like Robert Prechter, the Elliott Wave theorist, whose predictions of an epochal market collapse were discussed in this column two weeks ago. To the contrary, he said, the future is bright, and the possibility of a double-dip recession “minimal.”
He pointed to significant economic problems — including the European debt crisis, the possibility that the Chinese juggernaut will stumble, and persistent high unemployment in the United States. But he said that here, at least, the Federal Reserve, under the former Princeton economics professor Ben S. Bernanke, would do what it took to maintain financial stability.
As for the stock market, Professor Siegel said, “there is every reason to believe that mean reversion will continue” — that is, that despite sometimes excruciating declines, the market over the long run will produce average real returns of more than 6 percent annually. “The shocks of the recent past shouldn’t alter investors’ belief in the future,” he said.
The spine of “Stocks for the Long Run” was a study of the United States market going back to 1802, using data from several sources. Over that period, he found that the stock market outperformed every other asset class. In stretches as long as 20 years — including the last 10 and 20 years, according to data provided to Sunday Business by Morningstar — long-term government bonds have sometimes outperformed stocks. But as holding periods lengthened, he found, the stock market has almost always pulled ahead. Other studies have found similar results in other countries.
Emphasizing dividend-paying value stocks and investing globally will bolster your chances, he said.
What’s more, when stocks are cheaper than average, as measured by the price-to-earnings ratio, positive returns became more probable in subsequent years. That is very encouraging for the current market, in which earnings have been rising despite widespread skepticism, keeping the P/E of the Standard & Poor’s 500-stock index at a modest level. Based on consensus estimates, it stands at 13. That compares with an annual average of 15.2 since 1945, he said.
If post-World War II patterns hold for the future, he calculated last week, prospects for stock investments are excellent: there would be a 96.6 percent probability of a positive return for the next 5 years, going up to 100 percent for 10- and 20-year periods. Average real returns would be stellar — about 11 percent annually in holding periods from 1 to 20 years.
But is he too optimistic? Many bears think so.
His views run counter to those of analysts like David A. Rosenberg, the former Merrill Lynch economist, now with Gluskin Sheff & Associates in Toronto, who said in a market commentary last week that “the fundamental trend remains negative,” both for stocks and the economy. The chance of deflation is rising, Mr. Rosenberg said, and stock prices can’t be justified by expected earnings or economic growth.
In fact, the P/E ratio is low only if forecasts for rising earnings are borne out — as Professor Siegel expects. And if investors are sufficiently worried, they may push prices down, regardless of earnings. The market “is priced inaccurately much of the time,” Professor Siegel said, but over the long term, this will balance out.
Then there’s a more basic question: Does the past — represented by all those years of market returns — actually predict the future?
Maybe not, said Lubos Pastor, a finance professor at the University of Chicago. Along with Robert F. Stambaugh, who, like Mr. Siegel, is a finance professor at Wharton, Professor Pastor wrote a paper last year implying that investors should be careful in assessing retrospective calculations of market performance.
USING an approach known as Bayesian analysis, they showed that uncertainty compounds as the horizon grows longer. “The possibility of climate change, nuclear war, events like that — they don’t show up at all” in retrospective calculations, Professor Pastor said.
Still, in practice, he agreed with many of Professor Siegel’s conclusions. At 35, Professor Pastor said, he is a tenured professor with a steady income, so he has put much of his retirement assets into stocks, which he expects to produce a high return. Still, he added, “It’s important to realize that stocks should produce higher returns, because they’re riskier.”
Professor Siegel concedes the point but says that if the probability of uncertainty increases over time, it would do so for all asset classes. Stocks remain the best choice over the long term, he said.
But then, he has always been comfortable with stocks. His younger brother, Jon, a New Hampshire wood turner with no particular interest in finance or economics, remembers that as boys in Highland Park, Ill., they would listen to radio news. “As soon as the market numbers came up,” Jon recalled, “Jer would say, ‘Shhh, I have to get this.’ He’d run into his bedroom” and start scribbling on his stock market chart.
Computers generate the numbers and charts for him today, and he says they give him hope for the future.
Read Full Article »