Jeremy Siegel – The Market is “Fairly Valued” But There are Two Big Risks
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 fifth edition, is widely recognized as one of the best books on investing. It is available via the link on this page. He is a “Market Master” on CNBC and regularly appears on Bloomberg, NPR, CNN and other national and international networks
I spoke with Jeremy on Wednesday, November 20th.
In our interview last year on November 20, the S&P 500 was at 2,641. Yesterday it closed at 3,119. That's a gain of 18.1%. Last year you said the market was below fair market value based on current earnings. So your forecast was very good, given that the average annual return has been about 9.8%. What is the fair value of the S&P 500 now? And what's your outlook for the coming 12 months, including December of this year?
Last year's stock market forecast turned out very well. As I looked through that commentary, I said the earning increases in 2019 will be much less than expected, most likely 4% to 5%. Last November, analysts projected a 12% earnings increase in the S&P 500 earnings. Now it is estimated to be about 5%. . That's close to the increase I expect for 2020 – about 5% from this year’s level.
By the way, I use S&P operating earnings in my calculations, which are a little more conservative than firm-reported earnings calculated by Bloomberg, Thomson-Reuters and others. Warren Buffett has said that he uses S&P’s estimates for judging valuation.
Based on 2019 data, the market is selling for about 19-plus-times earnings. I said last year that fair market value for the S&P is closer to 17- to 18-times earnings. I'd notch that up a little bit because interest rates are much lower than they were a year ago, particularly long rates, which are so important for equity valuation.
Last year I thought that interest rates on the 10-year would fluctuate between 2.5% to 3.5% in the coming years. Now I think the range will be 1.5% to 2.5%.
Lower interest rates mean higher market capitalization. Price-earnings ratios of 18- to 19-– and you could argue even 20 – are very reasonable in this environment. Given that last year I said we were a bit of below fair market value, I'd say we're at fair market value now.
This means that by the end of 2020 we should expect 7% to 8% nominal return that includes a 2% dividend.
Warning: We all know that the standard deviation of one-year returns is about 20%, so a point estimate for one year has a high margin of error. But barring a serious recession, a 7% return is quite reasonable over the next 3-5 years