In the Classroom
Taking Stock: Investing for the Long Run
Wharton Professor Jeremy Siegel, speaking to Wharton’s Advanced Management Program in late October 2008, shows a chart of historical price-to-earnings (P/E) ratios in the stock market back to the 1800s. In the classroom, Siegel notes that none of the stock market ups and downs to date are outside of historical norms. If fact, the recent stock market downturns have finally pushed PE ratios into territories that make stocks an attractive long-term buy.
"Anytime you invest at or below the long-term trend line, you have done extraordinarily well in the market," he says, noting that investor Warren Buffet wrote in a recent New York Times editorial that he was increasing his investments in the market.
The fast-growing countries get overbought and overpriced. China is the fastest-growing country but has had the worst rates of return since the inception of the stock market. Growth tends to get overpriced in hot countries, sectors, industries, and individual stocks. People chase growth and pay too much for it.
–Jeremy Siegel, Russell E. Palmer Professor of Finance, speaking to Wharton’s Advanced Management Program
The current market conditions have not violated the thesis Siegel put forward in his best-selling 1994 book Stocks for the Long Run, now in its fourth edition, that stocks are the best long-term investment. It may not be surprising that Siegel, who has been called "the father of the 90s bull market," remains bullish despite the recent downturn.
He points out that while many investors are taking their money out of the market and putting it into cash, returns from cash since the early 1800s have been worse than any other investment. Stocks have outperformed investments such as gold, bonds, and U.S. treasuries in the long run and for most periods longer than a decade. Although there are many differences in markets around the globe, subsequent studies of global long-term returns have found that stocks also have outperformed other types of investments in markets around the world.
Siegel notes that the collapse of the Japanese stock market in the 1990s offers lessons for investors in the current environment, and an illustration of the resilience of markets. With the combination of a real estate bubble and a stock market bubble, the Nikkei fell from 39,000 in 1990 to 9,000 today, and Japanese P/E ratios dropped from 80 to around 15. "I am very comforted by Japan," he says. "It was more extreme than what we have now. Unemployment went up. Its GDP growth was not spectacular. But it wasn’t a disaster. It was not the Great Depression. People tell me this is going to be like the 1930s, but I say no."
Power of Sentiment
Emotions drive the stock market. "Only one out of four big moves in the market has anything to do with the news of the day. The other three have to do with sentiment," says Siegel. "On Oct 19, 1987 we had the greatest single market decline in history, 22 percent, but there is nothing we can point to that caused it," he says. "Euphorias and fears come over the market and move it.”
Global markets, in particular, have made massive readjustments in P/E ratios during the recent downturn. The Shanghai stock exchange, where P/E ratios had soared as high as 55, had come down to about 15 when Siegel spoke to the class. “No stock market is worth a 55 multiple, so I advised not buying, but now many are buys," he says.
Investors in hot markets such as China and India drove up prices in the past. "The fast-growing countries get overbought and overpriced," Siegel says. "China is the fastest-growing country but has had the worst rates of return since the inception of the stock market. People say: Get me into the fastest-growing countries and I don’t care about the price. You have to care about the price.” Siegel notes that slower-growth countries such as Brazil, with lower GDP growth, actually produced better returns. "Growth tends to get overpriced in hot countries, sectors, industries, and individual stocks. People chase growth and pay too much for it."
Population Implosion: You Can’t Eat Your Stocks
Siegel notes that there is a looming problem with investing that is much more fundamental than the recent financial crisis. With a rapidly aging population in the United States and other developed countries, there will not be enough buyers for the assets accumulated by retirees. "The aging of the population is the critical long-term economic issue facing the developed world," he says.
In the 1950s, the difference between average retirement age and life expectancy was just 1.5 years. In other words, the typical worker lived less than two years after retirement. But with retirement age falling and life expectancy rising, the gap is now 15.9 years. "There has been a major change in the way society is structured, from almost no retirement to a huge amount of retirement," he says. Lower birthrates in developed countries mean there are fewer workers to support these retirees. According to UN projections, the ratio of U.S. workers to retirees will drop from 7:1 in 1950 to 2.6:1 in 2050. In Japan, the ratio will fall to 1:1 in the same period.
Many retirees plan to live off of their investments. The problem is that the aging population not only depletes the supply of workers but also the supply of buyers for assets. "You sell your assets to the workers," Siegel says, "but if there are not enough workers to buy the assets, what happens? The big questions are: Who will produce the goods? Who will buy the assets?"
Stocks and other assets don’t have value unless owners can sell them to someone. "You cannot consume wealth. You cannot eat your stocks. Before you can consume, you must sell the assets. In modern society, you must find a buyer. If there are no buyers, you have nothing. You will starve to death with millions of dollars on paper. Stock markets may crash under these scenarios."
As he discusses in his book, The Future for Investors: Why the Tried and the True Triumph Over the Bold and the New, the buyers will likely come from global markets. Developing countries have rapidly growing economies and younger populations. "Throughout history the old have exchanged assets with the young," Siegel says. "In the future the U.S. is going to have to sell its assets to the rest of the world, which is much younger. This is like the retirees in Florida today selling to the rest of the country."
This means keeping global markets open is critical to the success of investors in the United States and other developed countries. "Our welfare depends on the growth of the developing world like never before in history," Siegel says. "Developing countries are going to produce the goods and buy our assets. It is a very, very critical change."
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