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The Re-Education of Jeremy Siegel

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Can an esteemed professor of finance ever escape his reputation as a “perma-bull?”

That was the question running through my mind during a long conversation with Jeremy Siegel, professor of finance at the Wharton School. We discussed stock valuations, bonds, government rescues, inflation — even gold. It was our first in depth conversation in 5 years and probably the 10th such conversation since the mid-2000s.

He ably defends his reputation — in television appearances, in Wharton’s classrooms, but most especially in books – by making use of his deep research into market history. “Stocks for the Long Run” was first released in 1994, as a data-rich scholarly work on markets. It sold more than 300 thousand copies, a solid number for this sort of book.

The data marshaled within the book explains much of Siegel’s philosophy: his research shows no other liquid asset class can generate the long-term returns of equities. The revised and updated 6th edition of SFTLR (as the Bogleheads call the book) is due out sometime next year.

The 2020 edition of Jeremy Siegel is similarly revised and updated. His thinking on equities has (surprisingly) progressed. A little more moderate than before, showing less of the perma-bull thinking that so many critics – present company included – have asserted. Siegel demonstrates not so much as a break from prior beliefs as an evolution; he evaluates equities within a world that is ever-changing. He still advocates investors need to own stocks for the long run, but he is very aware that real world events, from the dot com collapse in the 2000s, to the Great Financial Crisis of 2007-09, and most recently, the 2020 Covid-19 crash, impact how stocks behave. Not only stocks, but how he thinks about them as well.

The perma-bull label is a touch unfair. Siegel points to his Wall Street Journal column titled “Big-Cap Tech Stocks Are a Sucker Bet.” The timing was exquisite, published March 14, 2000, within days of the 1990s bull market’s top. His admonition to investors was both prescient and timely: “Many of today’s investors are unfazed by history — and by the failure of any large-cap stock ever to justify, by its subsequent record, a P/E ratio anywhere near 100.” Over the next 3 years, the tech-heavy Nasdaq market collapsed 80%.

That was the finance professor grinding through his data in 2000, while so many investors were caught up in the euphoria. But “valuation” still impacts Siegel’s views about equities; this time, it is driven by the relative change in bond prices, and their potential; for further capital appreciation.

For much the past 40 years, fixed income as an asset has been in a robust bull market. Inflation peaked around 14.7% in 1980; it was tamed and brought under control by then Federal Reserve Chairman Paul Volcker.  Ever since then, it has been a neck and neck race between stocks and bonds. Over the long run, equities are supposed to trounce bonds, according to Siegel’s research. Yet over the past 20 years, it has been Treasuries and Corporates that have thoroughly thrashed stocks. Since March 2000, the annualized returns for the S&P 500 (as calculated by Dimensional Funds) has been 5.87% versus 8.32% for long-term corporate bonds, and 8.34% for long term government bonds. That compounds to a thorough whupping of stocks since 2000, with total returns of 215.6% for the S&P500, 401.2% for corporates and 402.9% for Treasuries.

The broader and shorter duration Bloomberg Barclays US Aggregate Bond index averaged an annualized 5.20% return over the last two decades (versus 5.87% for the S&P 500). Are all of the drawdowns, risk and volatility of stocks worth it for less than a percent?

Siegel says it is. According to his analysis, the great bond bull market that began in 1982 is officially dead. He pushes back hard on the “Bonds for the long run” thesis, expecting mean reversion to play a large part. The bond outperformance for the past two decades is a function of an aberrational era, caused by an unusual spike in inflation in the 1970s. That led to a crash in bonds and a massive long term recovery. Congress and Federal Reserve actions during each of the last three crises – 2000, 2008-09, and 2020 – have driven yields to such low levels, they have nowhere left to go but up. (Siegel is not a fan of negative rates). “Bonds are going to do worse than inflation” Siegel said in our recent interview.  The recent nadir in interest rates mark a “low in yields for a generation, and maybe forever,” he adds.

The end of the bull market for bonds leads Siegel down some surprising roads. He believes that as all of the massive stimulus of Congress and the Fed work its way through the economy, it will (eventually) send inflation higher. Nothing like the 1970s, but we should expect rising consumer prices for a few years.

In light of this, he is making some rather startling recommendations for investors to make to their portfolios:

“75/25 is the new 60/40.” Lower expected returns for bonds, combined with higher life expectancies, are going to reduce the levels of bonds needed as ballast to offset stock volatility in portfolios. He expects bonds to deliver negative real returns. This is why he wants portfolios to hold even more stocks.

Lower your return expectations for equities.” Stocks are at elevated valuations, and if yields go higher, stocks will look even pricier. He does not expect the same 6-7% returns stocks have delivered over the past two centuries. Looking forward into the next century, he expects U.S. equity returns to be closer to 5-6%;

Stimulus: The government response today is very different than what we experienced in 2008-09: In addition to zero interest rates + $3 trillion in Fed liquidity, this time, there was more than $3 trillion in fiscal stimulus – with another trillion likely before the election. Under lockdown, savings rates have risen to double digit levels; Consumers have been stuck at home for months, building a mighty pool of pent up demand. Once a treatment and vaccine are available, Siegel sees a giant surge in consumer spending.

Inflation: Siegel was invited to participate in the 2010 Open Letter to Bernanke warning of hyper-inflation and the collapse of the U.S. dollar – and politely refused. His view in 2010 was all of  the Fed’s monetary actions merely made banks’ excess reserves bigger. It was neither lent out nor circulated, and that’s why there was no inflation post financial crisis.

The current situation has stimulus going directly into consumers’ bank accounts. He sees a big — but temporary — move up in consumer prices, with inflation rising to 3-5% over the next few years. Nothing like the 1970s, but a big change from the past decade. “Besides,” he adds, almost unable to help himself, “I think stocks are really good as a moderate inflation hedge.”

Buy a small slice of gold.” For the first time in his career, Siegel is recommending investors have “a small slice” of gold in their portfolios as an inflation hedge. He advises on several WisdomTree portfolios which uses his model recommendations. The SIEGEL-WisdomTree Longevity model, for example has a 3% weighting in Gold.

~~~

That Siegel remains bullish on equities is hardly a surprise. However, his thoughts have evolved over time. The investing environment has clearly changed, and with it, he has become more flexible.

This may be due in part to his work with Wisdom Tree, which manages over $40 billion in client assets. Real world feedback from actual portfolios creates a very different experience than academic research does. Perhaps that has added some nuance to how he sees the world.

Regardless, Siegel is the rare academic market theorist who came to the public’s attention for his core philosophical principles, but  seems willing to change his views as facts change. He still is bullish on stocks for the long run, but he has moderated his expectations of future returns.

Intellectual flexibility is all too rare in the worlds of academia and investing. It should be noted and applauded in those rare instances when found. Siegel, the academic and practitioner, is one of those rare birds whose thinking continues to evolve along with the markets.

 

 

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Economists Think Congress Could Create An Economic Disaster This Summer

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Congress has less than a month to hammer out a deal on the next round of stimulus before expanded unemployment benefits expire. State and local governments are starting to feel the pinch of budget shortfalls. And while the U.S. got a piece of (relatively) good news in last week’s jobs report, which featured an unemployment rate 2.2 percentage points lower in June than it had been in May, the economy has been thrown back into chaos in the meantime, with a number of states pulling back on their reopenings amid spiking COVID-19 infections and hospitalizations.

Our newest survey of economists highlights just how consequential governmental decisions over the next month may be: On average, these economists think that a refusal by Congress to extend unemployment benefits or bail out state and local governments is just as likely to hurt the economy as local economies staying open in spite of COVID-19 spikes — or even closing because of the virus.

In partnership with the Initiative on Global Markets at the University of Chicago Booth School of Business, FiveThirtyEight asked 31 quantitative macroeconomic economists what they thought about a variety of subjects around the coronavirus recession and recovery efforts. The most recent survey was conducted from July 2 through 6, which means the June jobs report was fresh on respondents’ minds — but so was the state of the pandemic, along with challenges ahead for lawmakers.

[Related: How Americans View The Coronavirus Crisis And Trump’s Response]

“There’s a distinct risk that between now and November, Congress’s ability to continue fiscal support will be very limited by election-year politics,” said Jonathan Wright, an economics professor at Johns Hopkins University who has been consulting with us on the design of the survey. “That could be more of a drag on the economy than the local and state shutdowns just because the effect would be so huge.”

With a congressional showdown looming, we asked the experts to estimate the probability that several policy decisions would have the biggest negative impact on U.S. gross domestic product in the fourth quarter of 2020. Among the five options we presented, the single most important to the economists was a decision by state and local governments to reclose their economies because of COVID-19 outbreaks. But a decision by Congress not to provide funding to state and local governments was close behind. And the weight given to choices made by the federal government — bailing out local governments, extending unemployment insurance and providing ongoing aid for small businesses — added up to be even more important when taken as a whole:

What are the biggest economic risk factors by year’s end?

Average probabilities that each scenario would have the largest negative impact on U.S. GDP in the fourth quarter, according to economists

Local or state response options Avg. Probability
Decision to reverse local economic openings due to COVID-19 spikes 26%
Decision to keep local economies open despite COVID-19 spikes 17
Total 43
Federal response options
Not providing funding for state and local governments* 23%
Ending/reducing expansion of unemployment benefits 20
Ending/cutting back on aid to small businesses 14
Total 57

* Funding to address budget shortfalls associated with COVID-19.

The survey of 31 economists was conducted July 2-6.

Source: FIVETHIRTYEIGHT/IGM COVID-19 ECONOMIC SURVEY

“[State and local governments] are facing severe budget crises and will be laying off workers to balance their budgets,” said Julie Smith, a professor of economics at Lafayette College. That, she said, could lead to longer periods of high unemployment and financial pain for many households. Meanwhile, she added, cutting back or ending the federal unemployment extension would cause many people’s incomes to decline dramatically, leaving them with much less money to spend — which could make a big dent in GDP.

Perhaps for this reason, there’s a lot of uncertainty in the economists’ fourth-quarter real GDP predictions. When we last asked the panel for its forecast, it thought that GDP would be growing by 4.1 percent at the end of the year, a big improvement from the -28.2 percent quarter-over-quarter annualized growth it foresaw for the second quarter of 2020. This time around, the panel is calling for less negative growth (-25.5 percent) in the second quarter and a very similar fourth-quarter growth rate to last time (3.8 percent). But the range around that end-of-year forecast has gotten a lot wider — a sign of just how much things could go wrong. The gap between our consensus forecast’s 10th and 90th percentile predictions for fourth-quarter GDP growth was 10.9 percentage points in the last survey; now that gap is 12.8 percentage points, with almost all of the extra uncertainty coming in the form of downside risk. (The panel’s consensus 10th percentile GDP growth forecast has dropped from -2.0 percent to -3.5 percent.)

[Related: Voters Who Think The Economy Is The Country’s Biggest Problem Are Pretty Trumpy. That Might Not Help Him Much.]

The economists weren’t especially optimistic about the trajectory of the unemployment rate over the course of 2020, either. The consensus prediction was that the unemployment rate in December would be 10.1 percent, which is only 1 percentage point lower than the rate in June — and is still comparable to the unemployment rate at the height of the Great Recession. Stephen Cecchetti, a professor of international finance at the Brandeis International Business School, pointed out that workers are increasingly likely to be losing their jobs permanently, rather than temporarily, which will make it harder for them to get back into the labor force. And he added that it will take time for the economy to adjust to a new reality where working from home is the norm, which could also keep the unemployment rate from falling quickly. Cecchetti was also among the economists who thought that in a worst-case scenario, the unemployment rate could skyrocket again by the end of the year.

“There are a lot of people who haven’t been exposed to the virus,” he said. “It’s not hard to imagine new outbreaks in places like New Jersey or Massachusetts that force us to shut down all over again.”

About half of the economists in the survey also thought the country’s top earners would end the year with an even greater share of the nation’s personal income. In order to get a sense of how much the panel thought the COVID-19 recession would increase income inequality, we asked about a new metric created by the Bureau of Economic Analysis, which found that in 2016, households in the top 10 percent of incomes (adjusted for household size) accounted for 37.6 percent of the country’s personal income. Fifty percent of the respondents thought this number would be significantly higher by the end of 2020 as a result of the COVID-19 pandemic, while 47 percent thought it would be about the same. Only one respondent thought it would be lower.

“My best guess is that this pandemic is going to worsen income inequalities,” said Sarah Zubairy, a professor of economics at Texas A&M University. She hypothesized that this was because job loss has been concentrated among lower-wage workers who can’t do their jobs remotely, and who may find themselves ricocheting in and out of the labor force if states have to abruptly pull back their reopening plans.

[Related: The Economy Is A Mess. So Why Isn’t The Stock Market?]

And in another sign that the U.S. has been knocked off course by the virus — and the subsequent leadership response — our survey panel overwhelmingly believes (with 90 percent agreement) that China will beat both America and the European Union on the road back to pre-crisis real GDP levels. In retrospect, according to Wright, this was kind of a “no-brainer” because China’s economic growth so far has been quite swift, and it has tools to enact sweeping fiscal stimulus that aren’t available to less centrally controlled economies like the U.S. or the E.U. But some of this might also be based on the Chinese government’s reputation for — how should we put this? — releasing overly favorable public data. “When all is said and done, if they don’t like the actual data they can fudge the numbers,” Wright said. “Put those three things together, and there’s almost no way they can’t be the first back.”

Wright also pointed to another ominous result in the survey: 19 percent of respondents thought that the 10-year average real U.S. GDP growth rate would be reduced by 1 to 2 percent per year. To be sure, the vast majority (77 percent) of economists thought the 10-year average growth rate would be reduced by less, although only one person thought it would go up. But the responses were still alarming, Wright said, because they indicated a serious degree of pessimism about the speed with which the economy will not just return to where it was at the end of 2019, but also catch up with where it would have been if the COVID-19 pandemic hadn’t happened.

[Related: In 2008, Everyone Thought The Recession Was Bad. But in 2020, Many Americans’ Views Depend On Their Party.]

However, Allan Timmermann, professor of finance and economics at the University of California, San Diego — who has also been consulting with us on the survey — was encouraged that the majority of respondents didn’t expect more long-term damage to growth. “This is still a large impact in terms of its cumulative effect on the economy,” he wrote in an email. “But it does suggest that most respondents think the economy will bounce back in due course — as opposed to leading us to a ‘lost decade’ scenario (as we have seen in Japan) with growth slowing down by an even larger amount.”

Overall, though, the latest survey responses paint a picture of America’s still-precarious road back to economic health. So much depends on the course of COVID-19 itself and how much the virus forces local economies to shut down again to slow its spread. But a lot is also riding on important policy decisions around the virus, which are still being debated. “I think economists have been surprised so far by the pace of the rebound,” Wright said. “But that hasn’t made them less worried about the weeks or months ahead.”


Subscribe to our coronavirus podcast, PODCAST-19




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Newsletter: Growth Hinges on Containing Covid-19

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This is the web version of the WSJ’s newsletter on the economy. You can sign up for daily delivery here.

Containment Policy

A strong economic recovery depends on effective and sustained containment of Covid-19, economists said in a new Wall Street Journal survey. More than 90% of business and academic economists agreed “somewhat” or “strongly” that economic recovery depends on containing the virus. “A virus resurgence will push consumer spending back into hibernation,” said Scott Anderson, chief economist at Bank of the West. Federal Reserve officials, including Chairman Jerome Powell, have voiced similar views in recent days, Harriet Torry and Anthony DeBarros report.

The U.S. entered a recession in February, the National Bureau of Economic Research determined last month. A recovery could already be under way. Economists in the survey estimated that gross domestic product contracted at a 31.9% annual rate in the second quarter. They expect the economy will expand at a 15.2% rate in the third quarter—though the obvious downside risk is from another big outbreak.

WSJ Video: Economists have long used letters of the alphabet like V and U to describe economic recoveries. But the coronavirus downturn is so different from past recessions that economists are coming up with new shapes to describe the potential return to growth. WSJ’s Jon Hilsenrath explains.

WHAT TO WATCH TODAY

The U.S. producer-price index for June is expected to increase 0.4% from a month earlier. (8:30 a.m. ET)

The Baker Hughes rig count is out at 1 p.m. ET.

TOP STORIES

Back to Work, Slowly

New applications for unemployment benefits edged down last week and the number receiving payments fell to the lowest level since mid-April. The fall in new claims extends a trend of gradual declines from a peak of 6.9 million in mid-March, when the coronavirus pandemic and mandated business closures shut down swaths of the U.S. economy. The modest easing of unemployment rolls, meanwhile, suggests new layoffs are being offset by hiring and recalling of workers, Eric Morath reports.

One other thing to watch in the weekly jobless claims report: The headline figures are for regular state programs. While those have been trending lower, the number of people receiving benefits through pandemic-response programs is going up. When you combine the array of long-established and brand new state and federal programs, total continuing claims hit a record high of 32.9 million during the week ending June 20, the latest data available.

Treasury Secretary Steven Mnuchin said the Trump administration is working with the Senate to pass a new bill for coronavirus-related economic aid by the end of July. Mr. Mnuchin said the administration supports a second round of economic impact payments to households, an extension of enhanced unemployment benefits for furloughed workers and a “much, much more targeted” version of the Paycheck Protection Program of forgivable loans for small businesses, Paul Kiernan reports.

Harley-Davidson said it would cut about 700 jobs as part of a global overhaul, the latest company to reduce its workforce as the coronavirus pandemic depresses economic activity. The job cuts amount to about 13% of the company’s global workforce. Other companies have also said recently they would shed workers, including Walgreens Boots Alliance, United Airlines and Levi Strauss, Austen Hufford reports.

Meatpackers are trying to replace human meat cutters with robot butchers. Companies like Tyson and JBS have been slower to automate than other manufacturing sectors. The coronavirus pandemic has changed that, Jacob Bunge and Jesse Newman report.

U.S. cases hit another daily record. New cases in the U.S. rose by more than 63,000, as hospitals in Texas, California and other states struggle to accommodate a surge of new patients.

What’s behind new Covid-19 outbreaks? America’s patchwork of policies. Skyrocketing coronavirus cases in the South and West reveal missteps at all levels of government, Arian Campo-Flores, Rebecca Ballhaus and Valerie Bauerlein report.

Individual companies are often forced to step into the breach. Starbucks will require customers in the U.S. to wear masks at company-operated stores starting next week, as retailers look to keep employees and patrons safe, Heather Haddon reports.

Can We Build It? Yes We Can!

Gold is climbing toward a record high, oil futures went from minus $40 a barrel to $40 in a month and a half, but the hottest commodity in the U.S. these days is wood. Prices for forest products like lumber and plywood have soared because of booming demand from home builders making up for lost time, a DIY explosion sparked by stay-at-home orders and a race among restaurants and bars to install outdoor seating areas. Lumber futures are up more than 85% since April 1, Ryan Dezember reports.

WHAT ELSE WE’RE READING

Was shutting down the economy worth it? “Based on the best currently available evidence, we estimate that, by the end of 2020, Covid-19-mitigating public health measures will save between 500,000 and 2,700,000 lives in the U.S.; however, the economic downturn from shelter-in-place measures and other restrictions on economic activity could create a collateral loss of 50,400-323,000 lives. This manuscript concludes that Covid-19-mitigating public health measures are justified; however they can create potentially significant, albeit less overt, mortality,” Olga Yakusheva, Eline van den Broek-Altenburg, Gayle Brekke and Adam Atherly write in a new working paper.

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Real Time Economics has launched a downloadable calendar with concise previews forecasts and analysis of major U.S. data releases. To add to your calendar please click here.

 



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Reclaiming freedom

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We might be seeing a significant political change, with the left reclaiming freedom and anti-statism from the right.

I'm prompted to say this by the Black Lives Matter slogan, "defund the police" which invites us to see the state as an oppressor. As Grace Blakeley recently tweeted:

People know that the state is fucking them over just as much as their boss or landlord – in fact, it’s helping their boss and landlord fuck them over even more…Rather than saying ‘just give more state power to the goodies (us)’ we need to start saying ‘put power where it belongs – in the hands of working people’.

If we read this alongside the disappearance of right-libertarians (some of whom discovered that they like racism and inequality more than small government) and emergence of big government Toryism, we see a big change from a few years ago. Back then, it was the right who called for a smaller state and much of the left that wanted a bigger one. Now it is, if anything, the opposite*.

In one sense this is a return to normality. Historically, advocates of freedom were opponents of the existing order, such as Tom Paine, John Stuart Mill and – yes – Adam Smith**. And, of course, Marxists have long regarded the state as "a committee for managing the common affairs of the whole bourgeoisie" and looked forward to it withering away.

Which poses the question: why are things now changing (back)?

One reason is that the left has learned that states are indeed often repressive. I'm thinking here not just of police killings but of the social murder that is austerity and tough benefit sanctions, and the forced deportations of black Britons (something still going on).

Secondly, they've learned that, as Grace says, it is not good enough to "give more state power to the goodies". Yes, New Labour did make significant achievements in tax credits, Sure Start and better funding of schools and the NHS. But many of these have been reversed by the Tories in the subsequent decade. The left cannot pin its hopes merely on winning temporary (and partial) control of the state.

Thirdly, changes within capitalism have changed the state. Of course, capital (pdf) has always wielded power over governments. But there was a time when this was relatively benign. In the post-war war mass production Fordist capitalists needed a mass market and hence an affluent working class. Extractive finance capital, though, doesn't. It needs cheap and plentiful money which fiscal austerity helps provide. General Motors needed a large well-paid working class; Goldman Sachs, not so much. This means there is now more tension between the needs of working people and the function of the state than there used to be.

All of which poses the question. What would anti-statist leftism look like?

Many of you might think the slogan "defund the police" goes too far. No matter: we don't know what's right unless we know what's too much. And what is right – as Elinor Ostrom showed – is that the police should be small and locally accountable. Also, there's a strong case for decriminalizing drugs, in part because it removes a pretext for the police to harass black people.

A high universal basic income would also expand freedom, not just by removing the harsh conditionality of Universal Credit, but also by giving us the freedom to reject exploitative labour or to drop out of the labour market to care for others or to train for better work. As Guy Standing says (pdf), "basic Income’s emancipatory value exceeds its monetary value."

Also, left-libertarianism must empower local communities, and embrace the community wealth-building advocated by Martin O'Neil and Joe Guinan and pioneered by Preston council. In weakening the power of central government, localization mitigates the damage done by Tory austerity. And it also gives local people more republican freedom – the freedom to collectively control more of their own lives.

There's something else, which the Black Lives Matter movement is also highlighting. It's that slavery teaches us something about economics. As Peter Doyle shows in a brilliant paper (pdf), markets produce incentives to undermine others' agency. Although slavery is the most extreme example of this we also see it in everyday capitalist labour markets. As Marx said, when we they start work workers leave behind the realm of equality and freedom and become mere factors of production. Left-libertarianism would put in place institutions to resist this and expand the realm of genuine agency. This would comprise worker coops and more local say over public services.

I say all this not to offer detailed blueprints: Marx was right to be sceptical of these. Instead, the point is that the left can and should pick up the cause of freedom now that the right has abandoned it.

* We mustn't be misled by the right's loud assertion of a right to free speech. What they are really proclaiming is the "right" to spout rubbish without any comeback, which is an altogether different matter.

** If you think the Adam Smith Institute is a representative guide to Smith's thinking, the wallet inspectors would like to meet you.



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