Many market pundits and investors are worried about the trajectory of the U.S. stock market. There are deflationary pressures everywhere, trouble brewing in China and oil prices that continue to give in to gravity. But Jeremy Siegel isn’t one of them.
Calling himself the “token bull” of Inside ETFs, Siegel, professor of finance at The Wharton School, said bullish investors today are an “endangered species.” But there is a bullish case left for equities and the markets.
Bullish Case For Stocks
From a price-earnings-ratio perspective alone, long-term equity valuations show that U.S. stocks are still delivering real returns in line with historical norms—6.7%. Yes, we are entering a period of lower returns for all asset classes, including stocks, he says, but real returns on equities should remain relatively close to that historical norm if P/E ratios are any indication.
Helping the case for U.S. stocks is the fact that the collapse in interest rates—the “biggest surprise development of the last 20 years”—coupled with increased risk aversion, aging investors, a growing desire for liquidity and de-risking of pension funds, have helped fuel demand for bonds, cutting yields lower.
This means real bond yields are going to be about 1-1.5%; real short-term yields are at zero; and the long-run nominal federal funds rate is at 2%, Siegel says. In other words, when investors don’t get the yield they want in bonds, they are going to be turning to stocks, because in that context, a 3-5% return sounds pretty good.
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Fed Realizing ‘New Neutral’
The Federal Reserve should help make that happen. Since 2008, the Fed has been predicting 3 to 4 hikes, “and they never did it. The market knows they are never going to do it,” Siegel said.
“The Fed is slowing waking up to the new neutral,” he said. “It’s going to basically be on hold going forward, and that’s going to be really good for returns and the market.”
“The most overused term in the past few years is ‘bubble,’” he added. “We are not and have not been in the last six years out of line with fundamentals.”
If U.S. stocks should continue to deliver positive results, there’s no question that deflation threats are real—and those threats are helping undermine investor sentiment.
Deflation Is Real
Oil is perhaps the biggest example of that right now. That’s no surprise when you consider there is $2 trillion in infrastructure based on oil and capital devoted to the energy segment, Siegel notes. Moreover, almost 30% of capital expenditures in the past five years was related to oil in one way or another, he says. What happens in oil has huge ramifications globally.
Oil has gone from its high days of $100-plus a barrel to flirting with a $20 price tag. Producers such as Saudi Arabia have shown their commitment to slowing down the U.S. shale revolution, and have kept supplies flowing into the market.
$60 Oil May Be The New Cap
Longer term, oil may never go back to the $100 level, and might actually be capped around $60, “but that’s a level we can live with and thrive on,” he said.
China is another deflationary force, and still a bit of wild card. There are several threats to the Chinese economy. There’s corruption. And there are questions as to what happens next if the yuan is “freed up” and it tanks against the U.S. dollar. That remains to be seen.
This environment should keep the Federal Reserve from hiking interest rates in any way significant. Good news for stock investors.
“We have the most bearish market sentiment since the Lehman Brothers collapse right now,” Siegel said. “Are these not buying points for investors when everyone turns bearish? I think so.”
Contact Cinthia Murphy at [email protected].