Jeremy Siegel, the beloved Wharton professor who juiced the bull market of the 1990s with his excellent Stocks For The Long Run, has had a rough go of late. First, the “long run” has turned out to be a bit longer than most people expected. Second, in the years since lending his name to WisdomTree mutual funds, Jeremy has gone into the regular market punditry business, and he’s now well-acquainted with the hazards of that:
“I think the stock market will have another winning year in 2008,” Prof. Siegel said last December. “For every percentage point that stock returns fall below 8% (my prediction) this year, they should exceed 8% next year (meaning, for example, if stocks gain 6% this year, they should finish 2008 up 10%). And I believe that financial stocks, which have plummeted 18% so far this year, will outperform the S&P 500 Index next year as the credit crisis fades.”
In any event, now that the S&P 500 is down 40% for the year, Jeremy’s banging the drum again. Stocks are now “dirt cheap,” he says. Specifically, Jeremy puts fair value of 1380 on the S&P 500, which is about 50% above the current level.
Here’s the problem, though: Just about every other smart academic and analyst we know doesn’t put fair value on the S&P 500 anywhere near 1380. Most, such as Jeremy Grantham of GMO, John Hussman of the Hussman Funds, Andrew Smithers of Smithers & Co., and Robert Shiller of Yale (a close friend of Prof. Siegel’s), put it about about 1000.
Prof. Siegel reaches his 1380 fair value estimate by applying a 15X P/E multiple to “normalized S&P 500 earnings” of $92 a share. “Normalizing” earnings–smoothing them to neutralize the business cycle–is the right way to calculate a PE ratio, and Prof. Siegel says he’s trending 15 years of earnings. We can’t figure out where he’s coming up with that $92, though.
Prof. Shiller continues to do a similar smoothing analysis on his Irrational Exuberance site, and when we average 15 years of S&P 500 earnings, we get about $55, a far cry from Prof. Siegel’s number. Using that number puts the PE in the 20s.
Robert Shiller’s “smoothed” P/E has been quite predictive. As you can see from the chart below, it suggests that stocks at the current level are not, in fact, “dirt cheap,” but are actually slightly above fair value. As do the calculations of numerous other experts we respect:
So we would love to hear more about Professor Siegel’s methodology.
UPDATE: We ran Prof Siegel’s analysis by an Applied maths PhD who is now a highly successful money manager. He explains Siegel’s mistake here.
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