Jeremy Siegel: The Market is Not in a Bubble; The S&P Could Reach 5,000 in 2022
Jeremy Siegel is the Russell E. Palmer Emeritus 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
This is my 14th annual interview with Jeremy, which we do just before Thanksgiving. He has been one of the most prescient forecasters among those featured in Advisor Perspectives. You can access our prior interviews here: 2020, 2019, 2018, 2017, 2016, 2015, 2014, 2013, 2012, 2011, 2010, 2009, and 2008.
I spoke with Jeremy on Wednesday, November 24th.
We spoke on November 19th last year, almost exactly a year ago. The S&P then was at 3,562; yesterday it closed at 4,689, for a gain of 31.7%. You correctly predicted that bull market in our interview. Congratulations. What should U.S. equity investors expect next year? What is the fair value of the S&P 500?
Last year was one of my best years for forecasting. It's important to understand why I had a number of accurate forecasts. It is because of my background in monetary theory and policy, the topic I wrote my PhD dissertation on. When I spoke to you last year, I saw the tremendous, unprecedented boost in the money supply that the Federal Reserve was creating. It turned out that 2020 was the greatest one-year M2 money supply increase in the 150-year history that we have such data. That money was going to the financial markets and then broke out into inflation in 2021. It's very hard to predict year-to-year movements in the stock market. My basic thesis is that this push of demand and liquidity is still going into the markets. However, the Fed is going to have to move very aggressively against it, and then there's going to be tremors in equities.
I see a upward move continuing until the Fed gets serious about inflation, and that could be as early as December 15th if we get another bad CPI number on the 10th of December. It might take until early next year, when the market will flatten out because the Fed is going to hike much faster than people think.
If I had to give a target next year, it is 5,000 for the S&P 500. But one should always take one-year predictions with a grain of salt given the volatility of the stock market.
Reaching 5,000 would be approximately a 7% gain. But there are many who believe that the market has reached bubble-like valuations and is due for a far more significant correction, say of 20% or more. What would you say to those who have that mindset?
I do not think the market as a whole is bubble-like. There are certain stocks that are bubble-like, and many of them are being hit badly and are selling off. But the overall market is fairly valued and not bubble-like. That said, we could have a 20% drop in stock prices. A bear market is more than a correction, which is defined as 10 to 20%. That's more of what might happen if the Fed steps on the brakes strongly next year.
But the market might go up 10% or 20% before it goes down 10% or 20%. As we all know, timing market moves is very, very difficult. I wouldn't be surprised to see a correction, but I also wouldn't be surprised to see the market up because of earnings that have been among the strongest we have had in history. Earnings are also the major driver of the market along with all the liquidity.
You noted last year that monetary policy was creating liquidity on Main Street for consumers and not for the financial intermediaries like banks on Wall Street, and that money would flow from consumers into stocks. With the Fed's announced plans for tapering, how will monetary policy affect the stock market going forward?
I have voiced this for some months: The Fed is way behind the curve. It started to taper too late and is tapering too slowly. It is indicating interest rate increases that are way too small and way too far in the future. The Fed will be forced to accelerate tightening greatly because I do not think – and I've been very strong on this opinion from the very beginning – that this inflation is temporary and fleeting. It is far more permanent, and the Fed has not come to grips with it.
When the market confronts the Fed making a strong pivot, you're going to see more volatility to the downside. That said, as I mentioned in your previous query, we are nowhere near bubble territory. The situation is very, very different from 2000. Valuations are much lower than they were in 2000. But most importantly, interest rates are gigantically lower than they were then, and even with a Fed rise in rates, interest rates are low relative to history and will support the market.
I'll come back to questions about inflation and interest rates in a second, but I want to ask about fiscal policy. We've passed the $1.2 trillion infrastructure bill, and the Build Back Better legislation is pending. How will those and other fiscal measures affect the market and the economy in general?
Far more important is what the Federal Reserve does. Those two measures, and we are yet to see exactly what the second measure looks like, are spread out over a number of years. They'll give a little bit of boost to the economy. I am in favor of what I call the “hard infrastructure bill,” which was bipartisan. We needed that, and that's a good investment by and large.
The other one has a lot of things that I don’t think are useful or that we can afford given the size of our deficits.
Nonetheless, these fiscal measures are spread out and will give demand a small boost. But the only thing that can stop inflation is the Fed stopping the growth of liquidity. I focus much more on the monthly money supply and liquidity figures that the Fed puts out than I do on those fiscal measures, although the final tax measures are yet to be worked out, and can be important...
You correctly predicted that we would see much higher inflation this year. Your prediction was in the 3 to 5% range, Core CPI-U is 4% and the headline number is 5.3%. What should we expect over the next year and longer term in terms of inflation?
I've been stating for quite a few months that based on the unprecedented monetary expansion that we have experienced since the pandemic began in March of last year, we are going to have a cumulative inflation of 20% to 25%. I'm not talking about one year. I'm talking about a period of three to four years. It could be 7%, 7%, 7%, or 5%, 5%, 5%, 5%. It's impossible to know exactly how it will be distributed.
I worry that we will not get control of the money supply. We get the data once a month on the fourth Tuesday; we got it yesterday. It is still increasing at a double-digit rate.
For the 35-year period from the mid-1980s to the pandemic, we only had 5.5% annual increase in the money supply. That equals real GDP growth plus inflation. That's exactly what monetary theory would say. Then when the pandemic hit, we jumped money supply in a few months by 15%, and since then we've been increasing at double-digit rates. The inflation could be worse than I expect if we do not get a handle on controlling that money supply.
There are a couple of arguments against the case for higher inflation. One is that the dollar is and will be the reserve currency, which is deflationary. Second is the argument that all this inflation may be the result of supply-chain issues, which will eventually be resolved. How do you respond to those two arguments?
I do not think the supply-chain issues are isolated and a result of temporary factors. They're mostly spurred by the dramatic increase in the demand, particularly for goods, that cannot be met. There are some container ships that are in the wrong place and there's some factory problems, and that makes it difficult to fulfill orders. But by and large, people are demanding too many goods and there's not enough people to produce them, and that's classic monetary, demand-pull inflation.
The excuse is to say inflation is due to supply-chain problems. But it is because there's so much demand. There's no question that the pandemic reduced the supply of workers permanently; they're not all coming back. That's a permanent supply-side impairment. That's not something that's going to rebound in coming months. The job openings are extraordinary, but they're coming back at wages that are far higher, and those wages will be pushed into prices that will sustain inflation going into 2022.
How confident are you in the Fed's ability to control or arrest inflation if it should rise to the levels that you are suggesting?
The only way is to raise interest rates. You can't keep interest rates at zero to 1% when inflation's going at 5% to 7%. That's free money. Banks have trillions of dollars of excess reserves and can easily put out the credit if it's demanded. People are going to say, "If goods are going up at 5% or 6% a year, I'm going to borrow to buy them now if my cost is 1% or 2%."
If the Fed raises interest rates, it'll put some pause in the stock market. It won't be free money anymore. People say, "I now earn zero on my CDs. But if I can earn 1% to 4% on CDs, I will think again about buying stocks that don't have earnings or are selling at 100-plus price-earnings ratios.”
Raising rates will slow down the stock market, but it'll also slow down borrowing, which will control the money supply. The control of the money supply will eventually bring the inflation rate down. But it will take rate increases far above what the Fed is talking about now. As inflation worsens, the Fed will have to pivot far more strongly.
The recent reappointment of Jerome Powell as chairman of the Fed gives him more freedom to pursue a much more aggressive course than when he was angling for the renomination – at least I hope so.
When we spoke last year, the 10-year yield was 86 basis points. Last night, it closed at 1.68%. That's an increase of 82 basis points. You predicted that rates would be between 1.75% and 2% this year, so you got that almost exactly right. Where will rates be a year from now?
I think higher, but not as high as inflation. The Fed may be forced to invert the curve, which means short rates above long rates. As we discussed last year, there is a dramatic demand for long bonds as a risk hedge asset.. It's a great cushion for short-term volatility. We might see the long bond next year at 2.5% to 3%, and we might see the short rate at 4%.
Inverted term structures may be more common in the future because the demand for long bonds has been very, very strong. Despite inflation, that demand has crept up. But the hedge demand for those bonds – in the lingo of the finance, the “negative beta” of those bonds – is huge.
Rates will move up, but not by anything like what we saw in the 1970s and 1980s, when inflation was much more persistent and much worse than what we have now. Some people are calling for 5% to 7% long-term yields. I don't think so. The long bond might stay below 3%, but short-term rates will have to go up more aggressively.
An inverted yield curve is often a signal for a recession. Do you see a significantly increased risk of recession as we look at over the next year or so?
We may have to go into a mild recession for the Fed to slow spending down enough. A flatter and maybe inverted term structures will be more common in our future than they have been in the past. To be sure, an inverted term structure has been an excellent predictor of U.S. recessions. But if you go to other countries in the world, it has not been as good.
But because of the strong hedge demand for bonds keeping their rates low, we're going to get inversions that mean only mild slowdowns, unless the term structure sharply inverts. Nonetheless, to slow down the inflation that I see coming, there is a strong possibility of a mild recession going forward.
To add to your list of correct predictions, last year you forecast that residential real estate would perform very well. That certainly has happened. What's your outlook for home prices for the next year?
In an inflationary environment, people want to buy real assets and homes are the quintessential real asset. We've already seen a 20% increase in home prices. We've almost already seen my prediction of 20% to 25% inflation in active commodity and housing markets. There's probably more strength to come. We could see another 5% or 10% increase, and it depends on how fast the Fed pivots and moves against inflation in the upcoming year.
But most of that 20% to 25% inflation in housing has already occurred. I don't see another 20% in 2022. But you're going to see strong markets and certainly strong regional markets in certain parts of the country. Florida has been extremely strong, being a no-tax state, while taxes are going to go up in many other states. Florida will continue to attract people given the aging of the population. There will be strength in certain regional areas that could send home prices up another 10% or so.
Outside of the broad U.S. stock and bond markets, which we've already discussed, which asset classes look exceptionally attractive and which ones should investors avoid?
We're already getting selloffs in those stocks that were the darlings of the slowdown. We all loved Zoom and Peloton, but they got way ahead of their skis, and there's competition for their services. Many don't have the moat around them that is needed to maintain super-high price-earnings ratios. Tesla has a brand that is absolutely unique, but there is competition even in the EV space.
I like value stocks and not just because of the reopening. People are going to be searching for yield that's inflation protected. Throughout history, dividend yields on stocks, although they're not guaranteed like bonds, match and in fact exceed the rate of inflation.
Dividend-paying stocks should be favored, particularly given our tax structure and that there may be a tax on buybacks that is in the House bill. That bill is going to the Senate, and we'll see if they retain it. But dividend-paying stocks tend to be value stocks and they may shine in 2022 for that reason.
We will also see higher interest rates. All that argues for the value sector. I've said this for a while, and I will be the first to admit that I'm very surprised how strong growth has been. But the so-called traditional growth stocks: Microsoft, Amazon, Apple, and the like, have been strong and are priced much more reasonably.
Tesla has a huge P/E ratio, but the FAANGs are now considered conservative tech. On the whole, conservative tech can still do very well in a rising rate environment because they are not way overpriced as some of the newer tech is. I'm not calling for a collapse of those high-priced stocks, but those that give you steady yield could do very well next year.
What risks are you most concerned about for U.S. investors?
Just recently we heard of a potentially dangerous variant of the Covid 19 virus. Hopefully current vaccines and therapeutics can control it. If not, certainly the market will take a hit, but current MRNA technology can produce a vaccine in a short period of time.
On the interest rate front, I don't think U.S. investors are expecting as sharp a pivot as is necessary by the Federal Reserve to control inflation. That is a risk. If Powell sees a bad inflation number, which we may get on December 10th, then by the FOMC meeting on the 15th he might double the rate of taper and we will start seeing interest rates hikes much sooner.
There's already an attempt by the administration to open up that possibility. Janet Yellen, secretary of the Treasury, is already hinting at that. Powell is not going to totally surprise the market, but there's a lot of denial about how fast he may have to go. My personal feeling is that eventually he's going to have to pivot even faster than what might be announced in December.
Outside of that, I see a strong economy going forward. We have an election next year, and it looks extremely favorable for the Republicans. People have said gridlock has been good for the stock market historically, but tightening by the Fed is going to be the major issue going forward.
Another risk we must deal with is cybersecurity, particularly the integrity of the electric grid. We could also get a massive cyberattack. I used to think that a stealth nuclear attack or nuclear material being released by terrorists was our biggest threat, but I have come to be more concerned with our electric grid and internet connectivity. We need to absolutely bulletproof those systems for our functioning society going forward.
As I mentioned at the beginning, I was schooled in monetary policy and theory and the understanding importance of the money supply. I am very surprised and disappointed that the Federal Reserve in all its statements has not even mentioned trying to get control of money growth. That's a big mistake and I hope the Fed will pivot towards realizing the importance of liquidity for inflation.
Inflation is the exact inverse of the price of money. You cannot ignore the supply of money when you talk about inflation. The Fed must pay attention to the supply of dollars it is putting into the economy.