Jeremy Siegel: 'Once the Market Has Fallen 50%, Your Future Returns Are Even Better'Published: March 18, 2009 in Knowledge@Wharton
U.S. stocks raised eyebrows this week and last, closing higher in six of seven trading days, including four in a row from March 10 to 13. But how does the market look for the longer term? In an interview with Knowledge@Wharton, Wharton finance professor Jeremy J. Siegel says he was pleased to see consecutive gains after so many declines. He adds that history provides lots of evidence that stocks remain good long-term investments, especially when they are down 50% from their peak.
An edited transcript of the interview follows:
Knowledge@Wharton: Were you surprised by the four consecutive positive closes that the market had last week?
Jeremy Siegel: I would say, "It's about time." We've had many consecutive declines.... It's time the bulls had a little bit of room to celebrate. Two events sparked the rally. The most immediate reason was Citibank's surprise announcement, around March 9, that its January and February operating data showed a profit. Obviously, Citi is the most beleaguered of all the banks. For it to say that it had a profit in the first two months of the year was surprising, and that boosted the financial sector. Ken Lewis, CEO of Bank of America, said the same thing a few days later. Then we got fairly good news on the retail sales front. The consumer is not tanking quite as rapidly as we had feared. That combination scared the short-sellers who had been counting on the market to fall and fall and fall. They covered their positions, and we had a nice, short cover rally.
Knowledge@Wharton: And GM announced that it would not need to draw upon its next aid installment from the government.
Siegel: Right. What's interesting about the auto market is that sales outside the U.S. -- around the world, actually -- did much better in February: China was very strong and so was Brazil. This was also true in Western Europe, with some discounting. So auto sales in February were better than expected.
Knowledge@Wharton: It sounds like when the market gets the right combination of signs, there's likely to be an upturn. Are there any signs now that would, in normal circumstances, support a turnaround, or at least a downturn that's not quite as steep?
Siegel: Yes. We had, finally, some good news on housing starts today, which were up more than expected. Of course, they had been totally devastated, but that did surprise a lot of economists. I'm not calling for stability there, because there is still so much oversupply in the market. I tend to look at the weekly jobless claims that come out every Thursday morning at 8:30. They are very sensitive indicators of the labor market. Among all the indicators I look at, they are the ones that give a good read about current trends in the employment area.
Knowledge@Wharton: Taking a longer-term look -- for folks who have just retired, or are about to retire, this market has been a disaster. Should people be shifting money from stocks to less volatile investments earlier in their retirement planning cycle? Or, said another way, should anybody past the age of 50 have a substantial part of their portfolio in stocks?
Siegel: I get more and more of those questions now. I certainly can understand -- it has been difficult for all of us, including myself. You know, I've advocated stocks. It has been a very painful period. Investors must keep a couple of things in mind.
First, you mentioned the word "50." I don't regard that as very old, I guess, because I'm well past that age. With modern medicine, a person aged 50 can look forward to at least 30 years or more of life. When you think in those terms, over 30-year periods, stocks have done extraordinarily well.
Even over the last 30 years -- despite the last 10 being so very bad -- it might surprise people to know that stocks have beaten bonds and have done well for investors. Once you get that far, it depends on a lot of circumstances. Once you get to 65, are you going to retire at that age? How is your health? Do you have other resources? What are your obligations? It's very hard to give a blanket recommendation.
One thing is very important for investors in stocks to keep in mind: You are now investing when stocks are down 50% from their peak. All the empirical studies, including my own, indicate that once the market has fallen 50%, your future returns are even better. It doesn't guarantee that next year will be good -- we know that in the short run, there's a lot of volatility. But the data are overwhelming. Once you're down 50% from the peak, there are almost no bad outcomes going ahead 10 years. When you're at the peak, such as we were nearly 10 years ago in March 2000, then there are periods of bad outcomes. We have had one of those bad outcomes, to say the least. But once you're down 50%, the chance of further rapid deterioration that keeps you permanently down is greatly diminished.
Knowledge@Wharton: Given the changes we have seen, and some of the ups and downs of the last decade that you just mentioned, has your definition of "the long run" changed at all? What is "the long run?"
Siegel: People can joke and say, "The long run is long enough so that you can be right." I mean, it's a continuous pattern. There's no break. The government issues a 30-year bond.... that's kind of considered the long run. People who are in their 20s, 30s or even 40s and have 401Ks are looking towards retirement. Thirty years is often that period. Obviously, as you get older, and depending on your resources, you might want to shorten it to 20 years or less. As I noted earlier, during the last 30 years -- even though the last 10 have been very bad -- stocks have offered investors a very good return. If you started in 1979, you got a return that was more than 6.6% a year. That is interesting. In the last 30 years, even with the terrible 10 we've had recently, the average return has been higher than the average of every 30-year return from 1871 and beyond. We had 20 fantastic years from 1981 to 2000 and we faltered subsequently.
Knowledge@Wharton: Looking at the broader economy, what will the beginning of the end of the downturn look like? What markers will you be looking for? You've mentioned the weekly unemployment numbers. Is there something that has a broader signal?
Siegel: Sure. There are two types of indicators here. There are the markets themselves. The stock market will tell me that the bottom is near. If we go back and analyze the stock market, it could be six to eight months before the recession officially ends. Let's hope early March was the low -- of course, we can't be sure -- but if it was, we're looking towards September or October as maybe marking the low of the economic cycle. So the stock market will be the first to respond.
I did mention that jobless claims are sensitive data. The first sign will be not that they're robust, but that they're not getting worse. We might actually see a reduction. Those numbers have been holding at around 650,000 jobless claims a week of people receiving unemployment benefits. We should also look at monthly payroll numbers, which have also been in the 650,000 range of losses. They will begin to moderate. They're going to be down to 400,000 or 300,000. Then, hopefully, by the middle of the year, they will be zero or even slightly positive. Now, that doesn't mean normal. Normal growth is 200,000, just to keep the economy growing at the rate of the growth of the labor force. But we should see moderating trends in the payroll loss and in jobless claims that tell us that the worst of the recession is behind us.
Knowledge@Wharton: To end as we usually do, could you give us your sense of what the individual investor should be thinking about? We've talked about people nearing retirement, and retirees.
Siegel: The problem with the safe government bonds -- although they have done well during the last five years -- is that their yields are so low. Even long-term treasuries are at 2.5% or 3%. I like inflation-protected bonds better, but even their yields are low. I would repeat that once the stock market has gone down 50% and you invest in it, you can expect, on average, a yield over five to 15 years of 6% to 8% after inflation. There's no bond that is that good.
I will say, by the way, that the so-called junk bond, or high-yield bond, looks attractive. You're getting 8% to 10% on many of them. You need a diversified portfolio. You need to go to a mutual fund that does a good job on diversifying. Those may also be attractive for individuals. But despite the discouraging returns on stocks, once they're down as much as they are now, history is very emphatic that they should be part of your future portfolio.