The Re-Education of Jeremy Siegel
Can an esteemed professor of finance ever escape his reputation as a “perma-bull?”
That was the question running through my mind during a long conversation with Jeremy Siegel, professor of finance at the Wharton School. We discussed stock valuations, bonds, government rescues, inflation — even gold. It was our first in depth conversation in 5 years and probably the 10th such conversation since the mid-2000s.
He ably defends his reputation — in television appearances, in Wharton’s classrooms, but most especially in books – by making use of his deep research into market history. “Stocks for the Long Run” was first released in 1994, as a data-rich scholarly work on markets. It sold more than 300 thousand copies, a solid number for this sort of book.
The data marshaled within the book explains much of Siegel’s philosophy: his research shows no other liquid asset class can generate the long-term returns of equities. The revised and updated 6th edition of SFTLR (as the Bogleheads call the book) is due out sometime next year.
The 2020 edition of Jeremy Siegel is similarly revised and updated. His thinking on equities has (surprisingly) progressed. A little more moderate than before, showing less of the perma-bull thinking that so many critics – present company included – have asserted. Siegel demonstrates not so much as a break from prior beliefs as an evolution; he evaluates equities within a world that is ever-changing. He still advocates investors need to own stocks for the long run, but he is very aware that real world events, from the dot com collapse in the 2000s, to the Great Financial Crisis of 2007-09, and most recently, the 2020 Covid-19 crash, impact how stocks behave. Not only stocks, but how he thinks about them as well.
The perma-bull label is a touch unfair. Siegel points to his Wall Street Journal column titled “Big-Cap Tech Stocks Are a Sucker Bet.” The timing was exquisite, published March 14, 2000, within days of the 1990s bull market’s top. His admonition to investors was both prescient and timely: “Many of today’s investors are unfazed by history — and by the failure of any large-cap stock ever to justify, by its subsequent record, a P/E ratio anywhere near 100.” Over the next 3 years, the tech-heavy Nasdaq market collapsed 80%.
That was the finance professor grinding through his data in 2000, while so many investors were caught up in the euphoria. But “valuation” still impacts Siegel’s views about equities; this time, it is driven by the relative change in bond prices, and their potential; for further capital appreciation.
For much the past 40 years, fixed income as an asset has been in a robust bull market. Inflation peaked around 14.7% in 1980; it was tamed and brought under control by then Federal Reserve Chairman Paul Volcker. Ever since then, it has been a neck and neck race between stocks and bonds. Over the long run, equities are supposed to trounce bonds, according to Siegel’s research. Yet over the past 20 years, it has been Treasuries and Corporates that have thoroughly thrashed stocks. Since March 2000, the annualized returns for the S&P 500 (as calculated by Dimensional Funds) has been 5.87% versus 8.32% for long-term corporate bonds, and 8.34% for long term government bonds. That compounds to a thorough whupping of stocks since 2000, with total returns of 215.6% for the S&P500, 401.2% for corporates and 402.9% for Treasuries.
The broader and shorter duration Bloomberg Barclays US Aggregate Bond index averaged an annualized 5.20% return over the last two decades (versus 5.87% for the S&P 500). Are all of the drawdowns, risk and volatility of stocks worth it for less than a percent?
Siegel says it is. According to his analysis, the great bond bull market that began in 1982 is officially dead. He pushes back hard on the “Bonds for the long run” thesis, expecting mean reversion to play a large part. The bond outperformance for the past two decades is a function of an aberrational era, caused by an unusual spike in inflation in the 1970s. That led to a crash in bonds and a massive long term recovery. Congress and Federal Reserve actions during each of the last three crises – 2000, 2008-09, and 2020 – have driven yields to such low levels, they have nowhere left to go but up. (Siegel is not a fan of negative rates). “Bonds are going to do worse than inflation” Siegel said in our recent interview. The recent nadir in interest rates mark a “low in yields for a generation, and maybe forever,” he adds.
The end of the bull market for bonds leads Siegel down some surprising roads. He believes that as all of the massive stimulus of Congress and the Fed work its way through the economy, it will (eventually) send inflation higher. Nothing like the 1970s, but we should expect rising consumer prices for a few years.
In light of this, he is making some rather startling recommendations for investors to make to their portfolios:
“75/25 is the new 60/40.” Lower expected returns for bonds, combined with higher life expectancies, are going to reduce the levels of bonds needed as ballast to offset stock volatility in portfolios. He expects bonds to deliver negative real returns. This is why he wants portfolios to hold even more stocks.
“Lower your return expectations for equities.” Stocks are at elevated valuations, and if yields go higher, stocks will look even pricier. He does not expect the same 6-7% returns stocks have delivered over the past two centuries. Looking forward into the next century, he expects U.S. equity returns to be closer to 5-6%;
Stimulus: The government response today is very different than what we experienced in 2008-09: In addition to zero interest rates + $3 trillion in Fed liquidity, this time, there was more than $3 trillion in fiscal stimulus – with another trillion likely before the election. Under lockdown, savings rates have risen to double digit levels; Consumers have been stuck at home for months, building a mighty pool of pent up demand. Once a treatment and vaccine are available, Siegel sees a giant surge in consumer spending.
Inflation: Siegel was invited to participate in the 2010 Open Letter to Bernanke warning of hyper-inflation and the collapse of the U.S. dollar – and politely refused. His view in 2010 was all of the Fed’s monetary actions merely made banks’ excess reserves bigger. It was neither lent out nor circulated, and that’s why there was no inflation post financial crisis.
The current situation has stimulus going directly into consumers’ bank accounts. He sees a big — but temporary — move up in consumer prices, with inflation rising to 3-5% over the next few years. Nothing like the 1970s, but a big change from the past decade. “Besides,” he adds, almost unable to help himself, “I think stocks are really good as a moderate inflation hedge.”
“Buy a small slice of gold.” For the first time in his career, Siegel is recommending investors have “a small slice” of gold in their portfolios as an inflation hedge. He advises on several WisdomTree portfolios which uses his model recommendations. The SIEGEL-WisdomTree Longevity model, for example has a 3% weighting in Gold.
That Siegel remains bullish on equities is hardly a surprise. However, his thoughts have evolved over time. The investing environment has clearly changed, and with it, he has become more flexible.
This may be due in part to his work with Wisdom Tree, which manages over $40 billion in client assets. Real world feedback from actual portfolios creates a very different experience than academic research does. Perhaps that has added some nuance to how he sees the world.
Regardless, Siegel is the rare academic market theorist who came to the public’s attention for his core philosophical principles, but seems willing to change his views as facts change. He still is bullish on stocks for the long run, but he has moderated his expectations of future returns.
Intellectual flexibility is all too rare in the worlds of academia and investing. It should be noted and applauded in those rare instances when found. Siegel, the academic and practitioner, is one of those rare birds whose thinking continues to evolve along with the markets.