Stocks, Bonds and Future Returns Prof. Jeremy J. Siegel ~ The Wharton School Jacobs Levy Center Conference ~ September 14, 2018 Past performance is not indicative of future results. For Financial Professional Use Only
Historical Total Real Return Indexes January 1802 – June 2018 $10,000,000. Stocks: 6.7% Real $1,372,018 Bonds: 3.5% Real $1,000,000. STOCKS Bills: 2.6% Real Gold: 0.5% Real $100,000. Dollar:-1.4%Real $10,000. BONDS $1599 $1,000. $263 $100. BILLS $10. GOLD $3.09 $1. $0.1 DOLLAR $0.048 $0.01 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 2018 Past performance is not indicative of future results. 2
P-E Ratio on S&P 500 , 1954-2018 PE 30 Median PE over period = 17.07 Double Digit Interest Rates You cannot invest directly in an index Source: Bloomberg 12/31/1954-5/5/16 3 Past performance is not indicative of future results. For Financial Professional Use Only
Definitions of S&P 500 Earnings Firm Reported : Most liberal, excludes asset § impairments, severance costs, Cash plant closing costs, litigation expense, pension value changes, and stock option expenses; 2017 $133.12; Est. 2018 $162.79, Est. 2019 $179.32. S&P Operating : Excludes some asset impairments § (except for financials) and severance costs; 2017 = $124.51 Est. 2018 = $157.79, Est. 2019. $177.00. GAAP : Mandates write-downs and asset § impairments, whether sold or not; Does not permit “write-ups” unless asset sold. 2017= $109.88; Est. 2018 = $142.99; Est. 2019 = $163.51 Warren Buffet, in 2017 Annual Report, said new § mark-to-market rules make GAAP earnings, for analytical purposes, “useless.” 4 Past performance is not indicative of future results. For Financial Professional Use Only
What do PE Ratios Mean for Returns? Earning Yield (E/P) is good predictor of long-term real returns. § Over past 140 years, P-E ratio averaged about 15, which § corresponds to 1/15, or 6.7% E/P, or real return on stocks. With S&P at 2871 (Sep 7), stocks are selling for about 18 times § 2018 and 16.1 times 2019 estimated operating earnings. A PE ratio of 18 forecasts a real return of 5.5% for stocks (or § about 7.5% nominal return with 2% inflation). This is more than 4 ½ percentage points over Treasury bonds, a margin economists call the “equity risk premium.” This premium is also above the historical average of 3% to 3 ½ %. 5.5% real returns comprised of 2% dividend, 3.5% real EPS § growth (2.5% of which caused by buybacks). Warranted P-E ratio is higher than historical average because § of virtually zero cost of indexing, allowing investors to receive far superior risk return trade-offs. You cannot invest directly in an index Source: S&P 1/18/18 5 Past performance is not indicative of future results. For Financial Professional Use Only
What is “warranted” Equity return? Indexed return over 19 th and first half of 20 th § century 6.7% real. But few, if any investors were able to achieve that § net of transactions costs (brokerage plus bid/ask spreads). Cost of maintaining cap-weighted portfolio likely § 150 bps per year or more in earlier period, leaving a net real return of about 5%. Today cost of indexation is virtually zero. An 18 P- § E ratio, leading to a 5.5% real return, can be regarded as the “new normal” equity return. Record low real interest rates, could push § equilibrium P-E ratio even higher . 6
Lower Payout Ratio = Higher EPS Growth Reported Real Real Real Dividend Payout Real EPS Dividend Capital Stock Yield Ratio Growth Growth Gains Returns 1871-2018 1.96% 1.56% 4.34% 2.36% 6.94% 61.5% 1871-1945 0.67% 0.74% 5.31% 1.32% 6.84% 70.8% 1946-2018 3.30% 2.42% 3.35% 3.44% 7.05% 51.5% 7
Shiller CAPE ratio In 1996. Robert Shiller, with John Campbell, § both at Yale, devised a “Cyclically Adjusted P- E ratio” to judge valuation of the market. Shiller averaged past 10 years of (real) per § share GAAP earnings on market index portfolio to compute his PE ratio. P-E ratio in August 2018 is about 32, based on § GAAP earnings, nearly double the 140-year mean value of the series. CAPE methodology forecasts forward 10 year § real returns on stocks of only 2.6%, about 40% of long-run average (but still more than bonds). FOR FINANCIAL PROFESSIONAL USE ONLY 8
Shiller CAPE Ratio: Reported and Operating 50.00 40.00 Overvalued 31.9 30.00 20.00 Mean = 16.9 10.00 Undervalued 0.00 1881 1885 1889 1894 1898 1902 1907 1911 1915 1920 1924 1928 1933 1937 1941 1946 1950 1954 1959 1963 1967 1972 1976 1980 1985 1989 1993 1998 2002 2006 2011 2015 CAPE Avg CAPE Source: Siegel, “The Shiller CAPE Ratio: A New Look” May 2016, Updated 9
Shiller CAPE Ratio: Reported and Operating 50.00 40.00 Overvalued 31.9 30.00 27.5 20.00 Mean = 16.9 10.00 Undervalued 0.00 1881 1885 1889 1894 1898 1902 1907 1911 1915 1920 1924 1928 1933 1937 1941 1946 1950 1954 1959 1963 1967 1972 1976 1980 1985 1989 1993 1998 2002 2006 2011 2015 CAPE Avg CAPE Operating CAPE Source: Siegel, “The Shiller CAPE Ratio: A New Look” May 2016, Updated 10
Real Per Share Reported Earnings Log Earnings Great Depression 1871 1876 1881 1886 1891 1896 1901 1906 1911 1916 1921 1926 1931 1936 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 Past performance is not indicative of future results. Source: “The Shiller CAPE Ratio: A new Look” J. Siegel May 2016 11
Real Reported, Operating and NIPA Earnings Reported Operating NIPA Log Earnings Great Depression 1871 1876 1881 1886 1891 1896 1901 1906 1911 1916 1921 1926 1931 1936 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 Past performance is not indicative of future results. Source: “The Shiller CAPE Ratio: A new Look” J. Siegel May 2016 12
CAPE Ratio Relative to Long-term Mean Shiller Total Return Portfolio 1987-2018 2.50 2.00 RPT: 1.71 OP: 1.53 1.50 NIPA: 1.36 1.00 0.50 1987 1988 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2010 2011 2012 2013 2014 2015 2016 2017 2018 Reported Operating NIPA Source: “The Shiller CAPE Ratio: A new Look” J. Siegel May/June 2016, Updated 13
Shiller CAPE Ratio: Forecast 3.5% real EPS growth 50 Forecast: 40 3.5% real Overvalued EPS Growth 30 23.8 21.5 20 Mean = 17.5 10 21.5 CAPE consistent Undervalued With 18 P-E ratio and 5.5% real equity return 0 1881 1885 1889 1893 1897 1901 1906 1910 1914 1918 1922 1926 1931 1935 1939 1943 1947 1951 1956 1960 1964 1968 1972 1976 1981 1985 1989 1993 1997 2001 2006 2010 2014 2018 2022 2026 CAPE Avg CAPE Operating CAPE Source: Siegel, “The Shiller CAPE Ratio: A New Look” May/June 2016, Updated 14
Published May/June 2016 FAJ 15
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