Jeremy Siegel’s Case For Equities
Jeremy Siegel has done more work on historical stock returns than pretty much anyone. He literally wrote the book on it, pulling stock data going back to 1802 for Stocks for the Long Run . In a recent Master in Business podcast interview he summed up his case for equities simply: What I showed was when you stretch out your holding period, up to 15, 20, 30 years, stocks actually were safer than bonds – had a lower variance and lower volatility than bonds. The long term, of course, gets overlooked with stocks. Everything – returns, variance, volatility – smooths out once you start to stack years together. I’ve broken down the S&P 500 returns over longer periods before. Since 1926, one-year returns range from a 54% gain to a 43% loss. If you put five years together, the annual returns range from a 29% gain to a 12% loss. Ten-year annual returns range from a 20% gain to a 1% loss. Fifteen-year annual returns range from a 19% gain to a 1% gain. Notice a trend? The range of possible returns shrinks as you extend the holding period. This is why stocks are Siegel’s asset of choice: If we know that return over that longer period of time is going to beat bonds by 3-4-5% per year, wow, that becomes the asset of choice for the long run. So why not only own stocks? Because people still fixate on one-year returns. It’s not much of a reach to suggest that fixation does more harm than good. It drives action. People look at one year’s return and expect it to continue. So money flows into stocks after a great year, and out after a terrible year. This need to act is why diversification is so important. Bonds become a psychological buffer for the short term craziness in the markets. And then there’s valuation. There are times when stocks become so expensive in the short term that it negates much of that long-term potential. The difficulty is in trying to time these periods because a high valuation doesn’t guarantee immediate poor returns – high priced stocks can always go higher in the short term – and valuation tools, like the CAPE ratio , don’t help the cause. Prior to the dot-com bubble, Siegel was a devout index fund fan: I was wedded to cap-weighted at the same time I said tech was crazy. And I didn’t know how to reconcile those two. Your typical index fund is market-cap weighted , which makes it extremely efficient. There’s just one big flaw. If a few stocks become wildly inefficiently priced (like internet stocks during the dot-com bubble) there’s no way to sell those stocks in a cap-weighted index. Rather, the cap-weighted index fund continues to buy more as the market cap rises. So Siegel’s solution was to change the weighting – essentially creating fundamentally-weighted index funds based on objective earnings data and opening the door for the rise of smart beta. Now, the fundamental weighting method isn’t perfect either. It won’t magically prevent a losing year. But if you’re only focused on one-year returns, it won’t matter anyway, you’ll be too busy acting before you ever see the benefits.