Jeremy Siegel: The “Irving Fisher of the 21st Century?”

From Investment Intelligencer

In his latest weekly letter, fund-manager John Hussman posits that Jeremy Siegel, the famous finance professor known as the "wizard of Wharton," is well on his way to becoming the Irving Fisher of this era.  Fisher, you may remember, was the well-regarded economist who opined in early September 1929 that stocks had "reached what looks like a permanently high plateau."  As Siegel himself noted in his excellent Stocks for the Long Run, Fisher made this remark two weeks before the start of The Great Crash.  Soon thereafter, his reputation was forever destroyed.

Siegel hasn’t said that stocks will never again fall, but in Hussman’s opinion, he’s now stretching his bullish interpretations so far that he’s making methodological errors.  Hussman cites a Financial Times piece in which Siegel argues that "Real returns can be estimated from the earnings yield, the reciprocal of the more popular price-earnings ratio. Since stock earnings are based on real assets, the earnings yield provides a good estimate of the real return on the stock market.”  Siegel then uses this logic to suggest that stocks may produce even higher returns in the future than they have in the past.

Hussman, also a finance PhD, has a number of problems with this logic, starting with the fact that Siegel is equating earnings with dividends.  He also ignores that 1% of stock performance over the past 80 years has come from multiple expansion, compares apples with oranges by conflating trailing and forward P/Es, and ignores that profit margins are at currently at record highs (thus producing artificially low P/Es).

This latter omission is the part of Siegel’s bullish argument that I find inexplicable.  As Jeremy Grantham has observed, earnings are "one of the most dependably mean-reverting series in finance."  It would be one thing if Siegel were to acknowledge today’s record profit margins and then argue that this time they won’t revert to historical means.  But he doesn’t even acknowledge them!  Instead, he just takes a simple current P/E and compares it to a century average based on average profit margins.

If Siegel weren’t so smart and well-informed, this omission might be understandable.  In fact, he is one of the world’s foremost market experts and a good friend of Yale professor Robert Shiller who popularized the "cyclically adjusted P/E".  So the only conclusions that one can draw are either that 1) Siegel doesn’t think profit margins will drop (an argument radical enough that it deserves to be made explicitly), or 2) he is now so wed to his bullishness that can’t let it go (wouldn’t be the first time this has happened to a market guru…).  A third, more negative interpretation is that now that Siegel is an advisor to ETF vendor WisdomTree, he can’t afford to be publicly bearish because it would be bad for business.  I’ll give him the benefit of the doubt on that one.

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