Jeremy Siegel is the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania and a senior investment strategy advisor to Wisdom Tree Funds. His book, Stocks for the Long Run, now in its fifth edition, is widely recognized as one of the best books on investing. It is available via the link on this page. He is a columnist for Kiplinger’s, a “Market Master” on CNBC and regularly appears on Bloomberg, NPR, CNN and other national and international networks
I spoke with Jeremy on Monday, November 20th.
In our interview on November 30 of last year, you said it was likely the S&P 500 would hit 2,300 by the end of 2016. It took until February 9 of this year to reach that value, and on Friday it closed at 2,579. That’s a gain of 23.4% from 2,090, which was the value when we spoke last year. That gain is consistent with the optimistic outlook you had last year. What is the fair value of the S&P 500 now and what is your outlook for the coming year?
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We’re just about at fair market value. Lower interest rates justify a higher than average price-earnings valuation. A PE ratio of 18 to 20 is reasonable, given that interest rates have remained even lower than I anticipated. From what I see with earnings right now, we are basically there.
The Republican tax plan and the corporate tax cut are important to the market, and they will be the driving force over the next month or so. I expect next year to be a tougher time for the market, but not necessarily a decline. We’ve had a huge gain since 2009, one of the biggest bull markets ever. It will be a year of digesting those gains.
When we spoke last year, you noted that S&P operating earnings were coming in between $106 and $107. They are now approximately $122 per share. That’s an increase of approximately 14.5%, while at the same time PE ratios have increased from 19.6 to 21.1. Looking forward, do you expect future returns to come from multiple expansion or from increased earnings?
We are going to have some increased earnings with the corporate tax cut, but certainly not to the extent that we have seen this year. Earnings per share might settle down to a 5% per year average increase. We are looking at about 20.5 PE right now on 2017 operating earnings. Of course, we’ve got the fourth-quarter yet to go.
I am looking at the S&P data that just came out and they predict operating earnings of $144 next year. I can see $10 from the tax cut, but I have a hard time seeing another $10 on top of that. That’s way too high.
We have rebounded from the terrible earnings in 2016 that, as I pointed out last year, were due to the oil price collapse. Obviously, we have seen an increase in the price of oil, which is now $56 a barrel. That’s a good rate for the U.S. It’s profitable for producers and yet low enough for users.
We are going to see a pop on the corporate side if the tax cut gets passed, which I anticipate will happen. But it will be hard to get much above 20- to 21-times earnings. That’s rich enough even for these low interest rates.
Virtually all the common stock-market valuation metrics, such as the Shiller CAPE ratio, the price-to-revenues ratio and the Buffett indicator, show valuations that are approaching the extremes of the dot-com era. What do you say to advisors who have pulled back on their equity allocations because of historically-based fears of overvaluation?
I have a lot of arguments to pick with the CAPE ratio. I published a Financial Analyst Journal article last year called The Shiller Cape Ratio: A New Look. I explained why it is strongly biased and way too bearish. When I first circulated my paper three years ago I got a lot of resistance. Now people are looking at it saying, “Jeremy, I think you’re right. It’s been so wrong for so long.” In fact, there are a number of papers that are circulating, some of which are going to be published, which are talking about why the CAPE is very biased toward bearishness. Mine had to do with the use of 10-year average earnings, which took into account the financial crisis with its zero earnings, which was due to the change in accounting procedures with GAAP that were not present in the earlier data.
The Buffett rule of stock value-to-GDP is totally silly, given that over 40% of the profits of the S&P 500 are gained from international, not domestic, operations. Why should you look at stock values relative to domestic GDP when a large part of the valuation comes internationally?
Margins are high on a historical basis, but there’s very good reasons why they are high, and why they might stay high.
By Jeremy Siegel, read the full article here.