Dr. Jeremy Siegel wants you to know that know is a great time to buy stocks. In fact, he says he’d be surprised if you didn’t get a 20% return on your investment in the next twelve months. Of course, Dr. Siegel’s crystal ball is proving to not be all that great. In 2007 he predicted that 2008 would be a great year for stocks and that financial stocks should do particularly well. So much for that prediction.
To understand his latest argument, Siegel is putting a fair market value on the S&P at 1380. Since the S&P closed today at 930, you can see why’d he think now was a great bargain, but how did he arrive at that 1380 number? Well he says that the long term fair market value for stocks is to trade at a PE of 15 and he then conjures up a figure for what the next 15 years of earnings for the S&P should be based on the past 15 or so- which is equal to $92 a share. $92 x 15 = 1380. Voila. I could almost hear Dr. Siegel add, “Wil-E Coyote. Super Genius!”
This article struck me as a bit fishy, and not just because I’m a bear. For one, having been a avid read of Bill Bonner, I knew from books such as Financial Reckoning Day: Surviving the Soft Depression of the 21st Century that the long term PE for stocks is to trade at 11, not 15. So I was curious as to how Dr. Siegel came up with such figure. It turns out, he made a mistake. Bonner and the bears are correct in saying that the average long term trailing PE for stocks is 11, 15 is the average PE for earnings from four years ago, not next year’s projected. Currently, stocks are trading at a PE of 18 compared to trailing earnings, as Dr. Siegel himself pointed out in the article where he calls stocks “dirt cheap”, and a PE of 18 is not cheap when the long term average is 11. The upshot is that Dr. Siegel made an error and that stocks are actually expensive on the order of 40% compared to their long term PE ratios, not 40% the cheaper as he claims they are.
The other thing that Dr. Siegel doesn’t seem to understand is that the long term average of stock PE is just that- a LONG term average. There are many bull market years where the PE is trading above 11 and many bear market years where it is trading below 11. Furthermore, these periods of over and under valuation tend to be grouped together in the time line: we see stocks priced well over the long term average through the 1920s and then under during the Great Depression of the 1930s. So if we are continuing the bear market slide that started in 2000, then we should expect stocks to be trading BELOW their long term average. Which means, if the trailing average is 11, we should expect to start seeing stocks trading at PE levels of 8 to 10 as they did in the 1970s. You’d have thought that the author of Stocks for the Long Run might have studied up on the market a bit to see just how long the “long run” can really be.
Of course, all of this bull market analysis is based on the notion that the next 50 years of American history should be more or less akin to the last 50 years or so, and that’s a claim I take issue with. American has dominated the last 50 years of world events as a titan with unmatched military, industrial and economic power. Looking forward 50 years into the future, do we really expect to see that continue? Which brings us back to Dr. Siegel; clearly he is wrong in his analysis, but it he simply mistaken or did he aim to reach for a conclusion that would make other parties happy.
Don’t get me wrong, we all make mistakes. Perhaps Dr. Siegel put less time and effort into his Yahoo columns that I put into this blog and just doesn’t get a chance to double check his math, but I don’t think so. I think Dr. Sigel fudged the numbers to arrive at a rosy outcome. If so, it wouldn’t be the first time a Macroeconomist has gone through a rather dubious trick of logic and math to reach the politically desirable conclusion. Indeed, John Maynard Keynes’s The General Theory of Employment, Interest and Money is nothing but a intellectual fraud filled with straw man arguments, shifting definitions, and math based on dubious assumptions, but it is heralded as a classic largely because it came to the desired conclusion of the day: the free market was inherently unstable unless assisted by the power of government. Macroeconomists are task masters at fudging their numbers to support the conclusions that they feel are popular. Why should we think Dr. Siegel is doing any different here?