stocks, bonds and future returns prof. jeremy j. siegel ~ the … · 2018-04-03 · annual stock...

Stocks, Bonds and Future ReturnsProf. Jeremy J. Siegel ~ The Wharton School

May, 2016

Past performance is not indicative of future results. For Financial Professional Use Only

This presentation represents the opinion of Jeremy Siegel and is not intended to be a forecast of future events, a guarantee of future results nor investment advice

Important Information

advice. It should not be deemed an offer or sale of any investment product and it should not be relied on as such. This presentation is not to be otherwise used or distributed. Professor Jeremy Siegel is a Professor of Finance at the Wharton School of the University of Pennsylvania and Senior Investment Strategy Advisor to WisdomTree Investments, Inc. and WisdomTree Asset Management, Inc. The user of this information assumes the entire risk of any use made of the information provided herein None of Professor

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information provided herein. None of Professor Siegel, WisdomTree Investments, WisdomTree Asset Management or the WisdomTree ETFs, The Wharton School, nor any other party involved in making or compiling any information in general makes an express or implied warranty or representation with respect to information in this presentation.


Definition of Major Asset Classes / Indexes

• The source data on the return series for the major asset classes can be found in Professor Siegel’s book Stocks for the Long Run, 4th edition. Professor Siegel compiled his own proprietary indexes on each asset class and updates each data series from the book to reflect most recent periods.

• Stocks: The total returns after inflation on the broadest index of k il bl h i (S k l l i d 1802stocks available at the time. (Stocks-real-total return index: 1802-

2015)• Bonds: The total returns on an index on U.S. government bonds

after inflation. (Bonds-real-total return index: 1802-2015)• Bills: Total returns on U.S. Treasury Bills after inflation. (Bills-real-

accumulative index: 1802-2015).• Gold: The value of 1 dollar of gold bullion after inflation. (Gold-

real-price index: 1802-2015)• Dollar : The purchasing power of one US dollar. (Money: 1802-2015)

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• Index performance assumes reinvestment of dividends, but does not reflect any management fees, transaction costs or other expenses that would be incurred by a portfolio or fund, or brokerage commissions on transactions in Fund shares.


Risks

Note: Stocks are typically subject to increased risks compared to U.S. Treasury Bills while bonds risks compared to U.S. reasury Bills while bonds are subject to adverse consequences associated with rising interest rates that cause a decline in a bond’s price. A U.S. treasury bill has less risk than bonds because of its very short-term nature and the U.S. government is considered a good creditor. Gold is often invested in as a hedge for inflation, but there is market risk that gold prices fluctuate

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g p fwidely. The value of the U.S. dollar depreciates over time with inflation, so the primary risk is inflation risk.


Asset Returns

5Past performance is not indicative of future results. For Financial Professional Use Only

Total Real Return Indexes

STOCKS$1,029,045

$1,000,000.

$10,000,000.

January 1802 – December 2015

Stocks: 6.7% RealBonds: 3.5% RealBills: 2.7% Real

BONDS$1659

BILLS$273

GOLD $2.77$10.

$100.

$1,000.

$10,000.

$100,000. Gold: 0.5% RealDollar:-1.4%Real

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DOLLAR $0.051

$0.01

$0.1

$1.

1802 1811 1821 1831 1841 1851 1861 1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011

Source: Siegel, Jeremy, Stocks for the Long run (2014) With Updates to 2015Past performance is not indicative of future results. For Financial Professional Use Only

Annual Stock Market Returns

Real Returns

Long

Updated through December 2015

Long-Term

1802-2015 6.7%

Major Sub-Periods

I 1802-1870 6.7%II 1871-1925 6.6%III 1926-2015 6.7%1946-2015 6.7%

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Post-War Periods

1946-1965 10.0%1966-1981 -0.4%1982-1999 13.6%2000-2015 2.6%

Source: Siegel, Jeremy, Stocks for the Long Run (2014) with updates to 2016 Past performance is not indicative of future results. For Financial Professional Use Only

Worldwide Stock, Bond, and Bill Returns

8Source: Source: Siegel, SLR 5th ed, updates to 2016


Global Valuation


P-E Ratio on S&P 500 , 1954-2016

Median PE over period = 16.9PE 30

Avg PE when Interest Rates <8% = 19

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Double Digit Interest Rates

Source: Bloomberg 12/31/1954-5/5/16

You cannot invest directly in an index


Historical P-E of Nasdaq

600 Times EarningsgMarch 2000

11Source: Bloomberg 12/31/1995-03/02/15



When Was America’s Greatest Year?

New York Times Poll, April 26, 2016

of T

hose

Sur

veye

d


%

Definitions of S&P 500 Earnings

Firm Reported: Most liberal, excludes asset impairments, severance costs, Cash plant closing costs litigation expense plant closing costs, litigation expense, pension value changes, and stock option expenses. 2015 $109.03; Est. 2016 $118.50.

S&P Operating: Excludes some asset impairments (except for financials) and severance costs. 2015 $100.45; Est. 2016 =

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$ ;$114.74

GAAP: Includes all write-downs, expenses and asset impairments; Does not permit “write-ups.” 2015 $86.53; Est. 2016 $105.78.


PE Ratio of S&P 500 1871-2016

Average P-E Ratio 15.

14Source: Stocks for the Long Run (2014), updated 2016



What do PE Ratios Mean for Returns?

Earning Yield (E/P) is good predictor of long-term real returns. That is why 140 year average of 15 PE corresponds to 1/15, or 6.7% real rate of return on stocks.

2015 S&P 500 operating earnings at $100.45, about 11% less than 2014. Excluding energy sector, S&P operating earnings would be up 4% in 2015 and this includes the hit of 5% caused by the higher value of the dollar.

With S&P at 2050 (May 16), stocks are selling for 20.3 times 2015 S&P 500 operating earnings.

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The loss in the energy sector biases the P-E ratio of the market upward.

Source: S&P May 9, 2016



Beware the “Aggregation Bias”!

I wrote Wall Street Journal op-ed February 25, 2008 “The S&P gets its Earnings Wrong.”

Assume healthy firm A:$ ll $10 billion earnings; 15 P-E ratio

$150 b market Value Assume sick firm B:

$9 billion in losses; $10 billion market value

Cap-weighted Portfolio is 94% A and 6% B.

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P-E of Portfolio (A+B): Earnings = +1 billion, Market Value $160b P-E ratio 160.

This is a ridiculous valuation for the portfolio


P-E Ratios and Future Returns

The aggregation bias is currently about 2 points on the P-E ratio. Excluding the energy sector, S&P PE ratio is about 18.3 times last year’s operating earnings.

i i d $ f 2016 S&P 500 earnings are estimated at $114.74. If this estimate materializes, it results in a 17.9 P-E ratio based on all sectors (including energy).

A PE ratio of 18 forecasts a real return of 5.6% for stocks (and about a 7% -7.5%% nominal return). This is more than 5% over TIPS, a margin economists call the “equity risk premium.” This premium is also well

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the equity risk premium. This premium is also well above the historical average of 3% to 3 ½%.

Even a P-E of 20 forecasts a 5% real return for stocks (6.5% to 7% nominal return). This is still well above the historical margin on equities.

Past performance is not indicative of future results. For Financial Professional Use OnlySource: S&P Dec 2015

Historical Equity Risk Premium 1979-2015

Yie

ld

Mean Equity Risk Premium

Diffe

ren

ce

(%)

18You cannot invest directly in an indexSource: Yardini.com as of 06/30/2015Past performance is not indicative of future results. For Financial Professional Use Only

World P-E Ratios2015 2016 2017

19Source: Bloomberg 5/8/16 You cannot invest directly in an index Past performance is not indicative of future results. For Financial Professional Use Only

Shiller CAPE ratio

Prof. Robert Shiller of Yale invented a “Cyclically Adjusted P-E ratio” to judge valuation of the market.

He averages past 10 years of Earnings to compute his PE ratio.

P-E ratio December 2015 was 25.75 55% above 16.58 , the 140-year mean of the series.*

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CAPE methodology forecasts forward 10 year real returns on stocks of only 2%, about 4 ½ percentage points below long-run average.

Past performance is not indicative of future results. For Financial Professional Use Only*Robert Shiller, Yale Economics as of 3/31/2016

Shiller CAPE Ratio 1881-2015

40

50

25.75

Mean16.62

20

30

lica

lly

Ad

just

ed P

rice

to E

arn

ings

Rat

io

Overvalued

21Source: Siegel, “The Shiller CAPE Ratio: A New Look” Oct. 2014. Data as of 5/8/16

0

10

1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011

Cyc

Undervalued


Is the CAPE Ratio Too Bearish?

In 416 of the 422 months from 1981 through 2015, the actual 10-year real returns in the market have exceed forecasts using the CAPE model .

There have been only 9 months since January 1991 when the CAPE ratio has been below its mean.

CAPE methodology called the US stock market “overvalued” in May 2009, when the Dow was 8500 (now 18,000) and the S&P 500 was 919 (now

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( , ) (2060).

Source: “The Shiller CAPE Ratio: A new Look” J. Siegel May 2016


Real Per Share Reported Earnings1871-2015

Real Per Share Reported Earnings

s)

30.00

Real Per Share Reported Earnings

e R

epor

ted

Ear

nin

gs (

Log

Ear

nin

gs

23

3.001871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011

Great Depression

Source: “The Shiller CAPE Ratio: A new Look” J. Siegel May 2016*Real Per Share Reported Earnings is the per-share reported earnings adjusted for inflation.

Rea

l Per

Sh

are


Reported, Operating Earnings and NIPA* Profits

1871 - 2015

Real Per Share Reported EarningsR l P Sh O ti E i

10NIPA Profits

s) Real Per Share Operating EarningsReal Pre Share NIPA Profits

1

S&PReportedEarnings

er S

hare

Rep

orte

d E

arni

ngs

(Log

Ear

ning

s

24

1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011

Rea

l Pe

*NIPA: National Income and Product Accounts on S&P 500 Earnings

Source: “The Shiller CAPE Ratio: A new Look” J. Siegel May 2016Start dates based on data availability.


CAPE Ratio Relative to Long-term MeanShiller Total Return Portfolio 1987-2015

2.0

2.5

CAPE Reported Earnings TR (RPT)

CAPE Operating TR Earnings (OP)

CAPE NIPA TR Profits (NIPA)

1.5

CAPE NIPA TR Profits

RPT

OP

(NIPA)

25

0.5

1.0

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

NIPA

Past performance is not indicative of future results. For Financial Professional Use OnlySource: “The Shiller CAPE Ratio: A new Look” J. Siegel May 2016

Just Published May/June 2016 FAJ


Collapse of Collapse of Interest Rates


Ten-year TIPS yield 1997-2016

4%4%

2%

1%

0%

3%

28

0%

-1%

Source Bloomberg as of 03/07/2016You cannot invest directly in an index


Determinants of Real Rates

Economic Growth and Risk Aversion are important determinants of real rates.

Average GDP growth rate between 1960 and 2008 was 3 4% and that was TIPS yield CBO Predicts annual 3.4% and that was TIPS yield. CBO Predicts annual GDP growth at about 2% or less over next ten years, subtracting nearly 1 ½% from yield.

Little demand for funds by firms.

Increased risk aversion, high demands for liquidity, and the de-risking of pension funds increases demand f b d ld t th 50 t 100b f th

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for bonds, could cut another 50 to 100bps from the bond yield.

This means real bond yields will max out at 1% to 1.5%, real short-term yields at zero, at most.

This argues for long-run nominal Fed Funds rate at 2%Past performance is not indicative of future results. For Financial Professional Use OnlySource Congressional Budget Office as of January 2015

March Fed “Dot Plot” vs Markets

1.40%

2.40%

3.30% 3.50%

Projected

Fed

Fu

nd

s Rate

2016 2017 Long Run

Source: Bloomberg and Fed Reports

2018

0.94%

e (%)

30

0.71%

0.52%

Dec 2017Dec 2016

(5/8/16)

Dec 2018


Negative Interest Rates

If banknotes were freely available and costless to store, interest rates could

b inever be negative.

Limit to how negative rates can be is determined by the cost of storing banknotes.

Fed is miles away from negative rates.

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y g

Negative interest rates are a proper policy tool and should be employed when deflation is a threat.


$2424

Consumer Price Index (CPI) S&P 500 Dividends

Dividend Income beats inflation

Entire Drop of DividendsDue to Financial Sector

S&P 500 Dividends Inflation

1957 2015 5 65% 3 73%

$1000834

CPI

Dividends

1957-2015 5.65% 3.73%1970-1989 6.46% 6.22%1990-2015 5.40% 2.46%Data as of December 31, 2015

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$100

Source: Bob Shiller, http://www.econ.yale.edu/~shiller/data.htm

Data to December 31, 2015



The Shocking Productivity Collapse

2.2% per year Long Term Average

33Source: Deutsche Bank 2016. AR: Accounts Receivable.


Why this Productivity drop?

Increase in activities that do not add to GDP, such as compliance, overseeing , p , gnew regulations.

Decline in educational standards, poor preparation for job market.

Are we computing GDP correctly? How do you treat “free services” such as

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How do you treat free services such as provided by smart phones or Google? How do we compute output in many service

sectors, particularly health care?


Total Real Return Indexes

STOCKS$1,029,045

$1,000,000.

$10,000,000.

January 1802 – December 2015

Stocks: 6.7% RealBonds: 3.5% RealBills: 2.7% Real

BONDS$1659

BILLS$273

GOLD $2.77$10.

$100.

$1,000.

$10,000.

$100,000. Gold: 0.5% RealDollar:-1.4%Real

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DOLLAR $0.051

$0.01

$0.1

$1.

1802 1811 1821 1831 1841 1851 1861 1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011

Source: Siegel, Jeremy, Stocks for the Long run (2014) With Updates to 2015


Important Information• You cannot invest directly in an Index. Index performance does not represent actual fund

or portfolio performance. A fund or portfolio may differ significantly from the securities included in the Index. Index performance assumes reinvestment of dividends, but does not reflect any management fees, transaction costs or other expenses that would be incurred by a portfolio or fund, or brokerage commissions on transactions in Fund shares. Such fees, expenses and commissions could reduce returns.

• The S&P 500 Price/ earnings ratio is defined as the S&P 500’s net income per share di id d b it i d l l Th S&P 500 I d i it li ti i ht d i d f 500

gdivided by its index level. The S&P 500 Index is a capitalization-weighted index of 500 stocks selected by the Standard & Poor's Index Committee designed to represent the performance of the leading industries in the United States economy.

• WisdomTree Investments, its affiliates and their independent providers are not liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein.

• Certain index performance information utilizes data provided by the Center for Research in Securities Prices Graduate School of Business University of Chicago also know as

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in Securities Prices, Graduate School of Business, University of Chicago, also know as CRSP®. CRSP data is not warranted or represented to be correct, complete, accurate or timely. CRSP is not affiliated with WisdomTree and shall not be responsible for investments decisions, damages or losses resulting from the use of the WisdomTree indexes or CRSP data.


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