Wharton professor emeritus of finance Jeremy Siegel had called the recent inflationary spiral well before the Federal Reserve anticipated it as a consequence of its massive COVID-era monetary stimuli. Now, he says inflation has peaked, and the Fed may not see the need for a rate increase of more than 50 basis points at the next meeting of the Federal Open Market Committee (FOMC) on December 13–14. If that occurs, it would mark an easing of a rapid-fire policy that has seen four consecutive 75-basis-point rate increases this year.
New data will persuade the Fed, according to Siegel. “Once [the Fed sees] the unemployment rate rise, jobless claims rise, and the real economy soften, it will back away and start talking about [an interest rate] decrease,” he said on the Wharton Business Daily radio show on SiriusXM prior to the FOMC meeting. (Listen to the full podcast above.) Overall, he expected the U.S. economy to grow maybe 1% this year.
Siegel’s big bet for 2023 is that equities have already priced in much of the bad news, be it China’s COVID policies or the Ukraine war, and are “10–15% undervalued on a long-term basis.” That, as he sees it, augurs “a very good year for equities.” He also bet on stocks over other assets in the revised edition of his book, “Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies.”
Below is an edited version of the interview.
Wharton Business Daily: Well, certainly the markets have had kind of an up and down year in 2022. Part of that can be tied to the state of the economy, the levels of inflation we’ve seen, the policy decisions by the Federal Reserve, and much more. What lies ahead for 2023? Let’s start out looking back at 2022.
Jeremy Siegel: Certainly, it’s been a disappointing year for equities. [The year was also the] worst for bonds relative to their historical performance. It was one of the few times in the past 15 or 20 years when both bonds and stocks have moved decisively lower, and the reason for that is very clear. The Fed was extremely late in its tightening mode. It should have started tightening early in 2021. In fact, it didn’t begin until March of this year, more than a year later than it should have.
Then, it seemed like the Fed, which was ultra-dovish — I had called Jay Powell the most dovish of the chair of the central bank that I had ever seen — suddenly became ultra-hawkish. At first, of course, I cheered last November when the pivot was voiced. It didn’t really start until March. They should have started raising it faster.
“Once [the Fed sees] the unemployment rate rise, jobless claims rise, and the real economy soften, it will back away and start talking about [an interest rate] decrease.”— Jeremy Siegel
But then, in the middle of the summer, I got alarmed that Powell and the Fed were raising it too fast. I saw a slowdown in the price increases, and I began warning that the danger now is over-tightening. Nonetheless, this has been the fastest increase in the Fed funds rate that we have seen probably in the post-war period.
As every finance student knows, financial assets are discounted at the interest rate plus a risk premium. When the Fed sharply raises the interest rate, those valuations must go down. And they did.
I attribute, therefore, most of the decline [in asset values] that we see to the rise in interest rates, not the fear of recession. Not that there isn’t a fear of recession — there most certainly is. But it is mostly an interest rate phenomenon that has caused this decline.
Wharton Business Daily: If the Federal Reserve had acted earlier, might they not have needed to act as aggressively with the rate increases, and then maybe we would have had a different impact over the last year and a half?
Siegel: Most certainly, without question. If they had started increasing [the funds rate at] the end of 2020 or the beginning of 2021, we wouldn’t have had to go as high, we wouldn’t have had the inflation that we have, and they wouldn’t have had to go as high as they have. And equities would not have had as big a burst as they had in 2021. But we probably would have had a milder increase [in interest rates] last year, and an increase in this year had they started earlier.
A Smaller Interest-rate Increase Ahead?
Wharton Business Daily: After we’ve had four 75-basis-point increases, it feels like it will probably be a little less in the December FOMC meeting, and then we’ll wean it down in the early months of 2023. Is that your expectation? Where might the target rate end up landing, at least in the short term?
Siegel: We’re going to get an awful lot of data before the meeting. My expectation is an [increase of] 50 basis points, and I would like them to stop there and pause and look around. Truthfully, I don’t even think another 50 [basis points] is called for. But that is certainly what is in the cards at this point for the December 14th meeting.
The Fed has inverted the yield curve, which of course means that they’ve set short-term rates above long-term rates. That has not been a good sign in the past for economic activity. My feeling is that the vast majority of inflation is behind us.
I have also strongly [said earlier] that the Fed is misreading the current inflation, particularly because of the way the government collects housing statistics. They still think housing inflation is going on at a very rapid rate, when in fact, all the evidence on the ground is that house prices and rental prices are now declining, not rising. But because of the lagging way in which the government collects those statistics, they’ll see the housing sector — a very important sector of core inflation — continue to rise throughout the rest of this year and in early 2023.
“We may just have a period of slow growth in the first half, the Fed then lowers the rate, and then we can commence growing again in the second half of 2023.”— Jeremy Siegel
Recession Not a Certainty
Wharton Business Daily: What’s your expectation, then, as we go into next year of the mindset around recession? Is it a certainty at this point?
Siegel: No, it’s not a certainty at this point. I think the Fed will start bringing down the funds rate by mid-year 2023. Now, some economists don’t think it will happen until 2024, but that would remain tight way too long, and I think they’re going to see the evidence in the slowdown. Once [the Fed sees] the unemployment rate rise, jobless claims rise, and the real economy soften, it will back away and start talking about [an interest rate] decrease.
That’s really going to encourage the market. We all know the market turns up four to five months before the economy actually bottoms. And don’t forget, this year we had a technical recession in the first half of the year — two declining quarters of GDP. Now, we had a mild increase in [GDP in] the third quarter, and the fourth quarter looks positive. However, we don’t have all the Christmas sales in yet as we speak. We’ll see how it is.
But this has been a very poor year for GDP growth. I think we’re going to be growing maybe only 1% this year. Normally you have recession following booms. So, we may just have a period of slow growth in the first half, the Fed then lowers the rate, and then we can commence growing again in the second half of 2023.
Wharton Business Daily: Are some of the questions being asked about the labor markets on point in terms of potential concern? Many companies have said they were going to cut their labor force, but that may include companies that overshot at the heights of the pandemic — especially the tech companies — and are now just right sizing.
Siegel: Yes, well, there was a lot of labor hoarding, not only by the tech companies, but by many others. That was because all they heard about how it’s impossible to hire. If you get someone, a body, a warm body, you keep them. And I think there was over hiring. One of the reasons why I think there was over hiring is if we a look at the productivity statistics in the first half of the year, they were the worst six-month productivity statistics in 75 years. They were hiring a lot of people, they were training them, the people weren’t working effectively.
When the economy slows, they could start getting rid of these excess people quite quickly. And we could see a rapid softening of the labor market as they realize that they don’t have to hoard labor anymore.
“A lot of bad news is now factored into prices. The surprises are more likely on the upside than the downside.”— Jeremy Siegel
Equities Poised to Revive
Wharton Business Daily: What’s your message then to equity investors for next year with all of these potential impacts on the table?
Siegel: I think we’ve seen the low, either in June or October — sort of a double low. We do have some wild cards that are being thrown in, particularly [the COVID restrictions in] China now, which is a significant issue. But when the Fed starts bringing rates down, even a mild recession would not cause earnings to go down enough to cause a new low in the stock market.
Now, no one in the short run should ever put their life at stake on what they say about what’s going to happen in the stock market. My feeling is that the stock market is anywhere from 10–15% undervalued on a long-term basis. And I think 2023 is going to be a very good year for equities.
Wharton Business Daily: You mentioned China, and we still have the war in Ukraine. How much do these global elements impact Wall Street? We know that Wall Street loves certainty and there’s nothing more uncertain than a war, and seemingly how the leadership in China deals with COVID and its zero-COVID restrictions.
Siegel: China is a bigger issue now than the war in Ukraine. Oil prices are down to pre-invasion levels, which is good for the world economy. There’s a lot of stress in Ukraine, and I’m not trying to minimize the human suffering that’s occurring there.
What’s going on in China though I would have never guessed a year ago. The zero-COVID policy is a total disaster. It looks like the Chinese are seeming to agree with that conclusion. (China has since eased much of the restrictions.) With more than a billion people and an economy that’s just about equal to ours in total size, it could be a big negative shock to go into this zero-COVID. I’m concerned about it.
[At the same time], there are potentially some good things that come of it. I think some of the great minds and entrepreneurs will leave China and come to the West, and decide [against] staying back in China. Many of our former Chinese students or Asian students often thought they’d learn in the U.S. and then they go back and make their fortunes in China. A lot of them are now wondering whether they want to go back.
Wharton Business Daily: So for 2023, are you cautiously optimistic?
Siegel: Yes, I’m definitely cautiously optimistic. Some people say that this is the most anticipated recession going into next year ever, because so many people are forecasting it. And when too many people forecast something, my feeling is that often, that drives the market below its fundamental values. So a lot of bad news is now factored into prices. I think the surprises are more likely on the upside than the downside.
Wharton Business Daily: Too many chefs in the kitchen, right?
Siegel: Well, they often say the stock market climbs a wall of worry. So if you wait for the skies to be blue to invest, you will never invest.