and Just Plain Wrong!
March 10, 2009
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I received quite a few emails asking my thoughts on Jeremy Siegel’s open editorial in the Wall Street Journal last week. I responded to Siegel’s article by submitting op-ed to the Wall Street Journal, but I found out that the WSJ doesn’t publish an op-ed in response to another op-ed. Here is my response to Siegel’s op-ed.
S&P 500 earnings topped out at about $84 a share in June 2007, while corporate profit margins were 44% above their average since 1980. At the time, these numbers were inflated by global bubbles in real-estate, commodities, liquidity, and growth expectations--a lot of global bubbles.
Since 2007, most of the bubbles deflated, stocks plunged, profit margins reverted to their mean (i.e. declined from above to below average), which in turn caused earnings to collapse. S&P 500 earnings estimates for 2008 were revised down to $28--a 67% drop from the highs. Suddenly, investors found that at 20-plus times earnings, the market is not that cheap, even after the markets’ precipitous drop.
As every action movie needs a hero, every cyclical bear market needs its bull.
Bull we've got--Jeremy Siegel, a Wharton professor, who wrote an op-ed article in the Wall Street Journal proclaiming that for the most part, the aforementioned factors were not the main causes of the earnings collapse. Instead, the flawed computation of the earnings of the S&P 500 is at fault. He explains that because Standard and Poor's, the creator of the S&P 500 index, doesn't weight earnings by market cap but simply aggregates them together, earnings misrepresent the true reality of corporate profitability and thus overstate the market's true valuation.
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