Valuation-Informed Indexing #202

By Rob Bennett

University of Pennsylvania Finance Professor Jeremy Siegel said recently that the Dow’s fair-value price-level is 18,500. He didn’t say why. I find that remarkable.

The article quotes Siegel as arguing that “we’re much closer to fair-market-value now than we were a year or two ago. I still think we are below fair-market-value, so I still think we’ve got 10 to 15 percent to get there in the markets.”? I am not trying to say that Siegel is wrong. I believe that he is wrong, but that’s not the point that I am trying to make. The point that I am trying to make is that there is a bizarre mix in this article (and in many other articles written about the stock market — I am pointing to this one only because it provides a clear illustration of a common phenomenon) of the scientific/rational/credible (Siegel views are being cited because he is a professor at a well-regarded university) and the silly/subjective/guesswork (no evidence is presented in support of Siegel’s claim).

Say that you wanted to warn people that Siegel’s view may be wildly off the mark? How would you go about it? He doesn’t say why he believes what he believes. So how can anyone go about raising doubts about the validity of the claim? To be fair to Siegel, it could be that Siegel stated the reason for his belief and the author of the article just did not bother to describe the reasoning Siegel used to come to his conclusion. My guess is that that is indeed the case.

But even in that circumstances I have a problem with Siegel’s claim.

I know of only two academic-based models for understanding how stock investing works. There’s Buy-and-Hold, rooted in the research of University of Chicago Economics Professor Eugene Fama. And there’s Valuation-Informed Indexing, rooted in the research of Yale Economics Professor Robert Shiller. Shiller’s P/E10 metric shows that stocks are insanely overpriced today. So Siegel obviously is not in the Shiler camp. Presumably he is a Buy-and-Holder.

That presents a problem.

Fama says that the market is efficient. That means that all factors bearing on the value of stocks are priced into the Dow value either immediately after they become publicly known or shortly thereafter.

Do you see the problem? If Fama is right, stocks can never be underpriced any more than they can ever be overpriced. Stocks are always properly priced in an efficient market. The price that applies when all factors bearing on price are taken into consideration is obviously the proper price.

So how can any academic argue that stocks are underpriced?

An individual investor can do that. There are obviously lots of individual investors who do that all the time. But Siegel is not being quoted at web sites because everyone wants to know his views as an individual investor. He is being quoted because he is an academic, he is presumed to possess a special understanding that makes his views more important than the views of ordinary investors.

But the view that Siegel is putting forward here is not rooted in either of the two academic models! The idea that stocks are underpriced makes no sense under the Shiller model. And the idea that stocks are underpriced makes no sense under the Fama model. The idea that stocks are underpriced makes no sense under either of the two academic models. And yet Siegel, a well-known academic, gives voice to that view and is quoted in the media for doing so as if his views possessed some special significance because he speaks with the authority of a well-informed academic.

Strange, no? It’s a very, very, very strange and very, very, very dangerous phenomenon, in my assessment.

Either you speak as an academic or you don’t. If you speak as an academic, your views should be given extra credibility because academics submit to scientific standards that render their views more significant than those who do not do so. Mixing up the academic, science-based stuff with the pure subjective opinion stuff is a dangerous practice. Those who hear Siegel’s words and do not parse them as carefully as I am doing here are likely to be taken in by them for entirely unjustified reasons.

If Siegel were speaking as an academic, it would be appropriate for someone going with a high stock allocation today to take comfort in his works. If Siegel is just sharing some vague thoughts that have gathered in his mind, the people hearing his words need to know that and it is not proper to cite him as a finance professor at the University of Pennsylvania. If he is just shooting the breeze, then the media outlets that quote him should let us all know that he is just shooting the breeze and that we should give his words the weight that we would give the words of any other investor shooting the breeze.

Please don’t think that it is my intent here to pick on Jeremy Siegel, whom I view as a very smart fellow who has made important contributions to our understanding of how stock investing works. Stocks for the Long Run is on my list of the ten most important investing books ever published. Siegel is entitled to his opinions and lots of people want to hear those opinions and web sites that report on those opinions are performing a service.

The sort of thing that I am talking about here goes on all the time. Media reports do not distinguish investing views that are rooted in research from investing views that are not rooted in research and they make a mockery of the idea that peer-reviewed investing research can rise to the level of science when they fail to do so.

Jeremy Siegel has his opinions on where stocks are headed and I have mine. We are both entitled to our opinions. He is a well-regarded academic and I am not. But his views should not be granted any extra credibility because of that distinction. Because Siegel’s view that stocks are underpriced is NOT rooted in research. Those views are merely the product of a perfectly nice and well-educated fellow letting us all know about some thoughts that have been passing through his mind in recent days.

Rob Bennett has recorded a podcast titled Risk Tolerance in the Real World. His bio is here.