and the Virtues of QE2
November 16, 2010
Jeremy Siegel is the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania and a Senior Investment Strategy Advisor to Wisdom Tree Funds. His book, Stocks for the Long Run, now in its fourth edition, is widely recognized as one of the best books on investing. It is available via the link below. He is a regular columnist for Yahoo Finance and is frequently quoted in the financial press.
I spoke with Professor Siegel on November 9.
When we spoke last year, it was December 23rd and the S&P was at 1,118. It’s now at 1,223. So it’s about 9.3% higher, and that’s within your band of prediction. It’s at the low end, but you were one of the few people at the time who was forecasting a bull market of any kind. What is your outlook now?
Well, it’s interesting. I actually looked back at last year’s interview, and I said, “Wow, I was pretty right on the stock market, but I was wrong on the interest rate.” I thought the Fed would start raising interest rates.
One of the most remarkable developments over the past year is that the economy has been weaker than I and most people expected, to say the least. I don’t think there’s a double-dip at all now, and I was not in that camp. But certainly I expected there to be a more robust recovery. Yet, despite that, earnings are higher than what I predicted and what almost all analysts predicted a year ago.
Think about this. The economy is much weaker, but earnings are higher. You can ask, “Well, how can that happen?” It happened in two ways. First of all, it was because of strong global growth and the fact that so much of corporate profit, particularly for the S&P 500, comes from global sales. It was also because of remarkable cost-cutting and efficiency gains that were made by corporations.
What are the two things we know are the most important ingredients in determining stock price? It is earnings and interest rates. Earnings are higher than expected. Interest rates are lower than expected. So, when I look at the fair market value now of the market, I see it appreciably higher than our current levels, and I can easily see the market growing 10-20% over 2011. And, by the way, I even see a nice gain through the end of 2010.
Do you feel that we’ve come to an end of the expansion of corporate profit margins, or is there still room for them to grow?
Margins are great. Certainly, we’ve done most of the cost cutting, and now we need the sales to increase. The leverage is huge. If firms can make profits with sales being as sluggish as they’ve been this year, think how much profit they’ll make if sales start going up. I’m one of those people who, whenever they announce the earnings and others say, “Oh my God, yeah, they topped their estimate on earnings, but they didn’t make their revenue,” I say, “Hey listen, that’s not bad.” I’d much rather they top on earnings and miss on revenue than fall short in earnings and make more revenue. If revenue is above what they expected and they can’t make their earnings, that’s not a good sign.
So, corporate America is levered up in such a way that when we do get that boost in spending, which I think will come in 2011, we will definitely get more profits.
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