At the CFA Institute at Baltimore, we had the pleasure of having Jeremy Siegel come speak to us this past Thursday. He was lively, engaging, and utterly convinced of his theses. Thanks to WisdomTree Investments for helping fund the endeavor.
He openly asked us to poke holes in his theories. This article is an effort to do that.
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1) Stock tends to get bought in when it is undervalued, and sold via IPOs when it is overvalued. Thus the time-weighted rate of return exceeds the dollar-weighted rates of return by a few percent. This dents the main premise of “Stocks for the Long Run.” Buying and holding is not possible, because valuable stocks are lost at the troughs, giving us cash, and we are forced to buy more near peaks, of overvalued stocks.
Dollar-weighted returns are what we eat, and they don’t vary much versus time-weighted returns when considering bonds or cash.
Also, in the present day, private equity plays a larger role, and they exacerbate the degree to which stocks get IPOed dear, and acquired cheap.
2) He spent a lot of time defending the concept of the CAPE Ratio, but not its execution. He began a long argument about how accounting rules for financials were behind the drop in earnings for the S&P 500 (.INX), and that American International Group Inc (NYSE:AIG), Bank of America Corp (NYSE:BAC), and Citigroup Inc (NYSE:C) were to blame for all of it.
Sadly, he seems not to know financial accounting so well. What was liberal in the early and mid-2000s was corrected 2007-2009. In aggregate the accounting was fair across the decade. Remember that accounting exists to try to measure change in value of net worth across short periods, and net worth at points in time.
Really, if we were trying to be exact, when a writedown occurs, we would spread it over prior periods, because prior accounting was too liberal – the incidence of the loss occurred over many years prior to the writedown.
Thus I find his argument regarding specialness of financial company accounting to be bogus – he is just searching for a way to justify valuations off of current earnings, rather than off of longer term measures.
3) The longer–term measures agree with CAPE:
- Market Cap/ GDP
- Financial Stress indexes
- Eddy-Elfenbein’s Stock Market if valued like a bond measure
All of these point to an overvalued market. But markets can be overvalued for a while. Why might that be in this case?
4) Because profit margins may remain high for some time. In an era where the prices for labor and resources are cheap, should it be surprising that profit margins are high? Those conditions will eventually change, but not soon.
With that, I would simply say that:
- Stocks do outperform bonds and cash over the long run, but not by as much as Dr. Siegel thinks.
- Stocks are overvalued by long-term balance sheet-oriented measures at present.
- But stocks may stay high because profit margins are likely to stay high – there will be regression to the mean, but not now.
Finally I would note that he was one of the most graceful and generous speakers to come speak to us in some time, took a long Q&A, staying longer than he needed to, and happily signing the books he had written. I showed him my First Edition version of his book, signed by him after speaking to the Philadelphia AAII chapter in 1995, and said, “We were much younger then.” He smiled and said, “Yes, we were.”
I may disagree with him on some points, but he is one very bright and personable guy.
By David Merkel, CFA of Aleph Blog