Financial Advisor reports on Wharton School of Finance Professor Jeremey Siegel’s comments at the annual Inside ETFs conference, where he critiqued the widely used Shiller P/E Ratio. Siegel did not necessarily attack the original logic of the Shiller P/E (which won its creator, Robert Shiller, a Nobel Prize). Instead, he noted that changes to the definition of generally accepted accounting principles (GAAP) earnings by Standard & Poor’s in 1990 have had an effect. Following the Financial Accounting Standards Board requirements, the GAAP change required mark-to-market accounting, which means companies mark down their assets when they have a loss but can only markup assets when they are sold.
Turning to the market, Siegel described himself as “the token bull.” He maintained that Fed policy is not “artificially inflating stocks” and we are not experiencing a new bubble. Nonetheless, he concurred with many observers that investors should expect lower returns going forward, but predicted about 5-5.7% real returns over the next decade. He cited slightly high valuations, slow economic growth, the risk aversion of an aging population, and a perplexing decline in productivity. On bonds, he predicted a bigger decline, with real returns around 1.0% to 1.5%.
Jeremy Siegel, a finance professor at the Wharton School of the University of Pennsylvania and senior investment advisor with Wisdom Tree Funds, offers his 2016 forecast in an interview appearing in Advisor Perspectives. Commenting on the current situation, he noted: “I have never seen a shortfall of earnings relative to estimates as sharp as we had this year. We had a total collapse in earnings.” Pointing to the energy sector he said: “no one thought oil would go down so far,” observing that “the S&P is not just a U.S. Index” because of “40% to 45% of its profits earned abroad.”
Looking forward, Siegel suggested that the S&P might reach 2,300 by the end of 2016 “if we get an earnings recovery.” He elaborated: “in the low-interest-rate environment we are in, a [PE] multiple of 18 to 20 could be considered a fair market value. If you apply that multiple to an earnings bounce back you get 2,300 for 2016 on the S&P.” He uses operating earnings, which are “extremely conservative” and thus “much lower” than reported earnings, in discussing the 18-20 times earnings multiple. He also believes we will “have permanently lower [interest] rates.” To summarize, he stated that “the major driver of equity prices will be a bounce back in earnings. If we don’t see a bounce back in earnings, we are not going to have a good year in stocks.”
Siegel said: “I am not worried about inflation next year,” but noted there may be “some price pressures . . . on the wage front.” He expressed concern about the labor participation rate as well and cited “tightening in the labor market” as a potential concern, along with “the very distressing productivity collapse that we’ve seen.”
With regard to emerging markets, Siegel observed that he “was clearly too early” when he previously predicted that EMs would reward investors over the long-term, noting that “many of the emerging markets are tied to those raw materials” that have seen their prices plummet recently. “Commodities have likely gone down as much as they are going to because there is so much bearishness in this area,” he opined, continuing “three to five years out that sector is going to be rewarding” because “we don’t need oil prices to go all the way back up; we just need them to stabilize to give value to many of these stocks.” While he observed that “a lot of the weakness is driven by China,” Siegel also pointed out that it’s current 3% growth rate “is still twice the U.S. level and three times the European level.”
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