Siegel: 'New Normal' Investing Opportunities

December 29, 2015

Jeremy Siegel, Ph.D., is the Russell E. Palmer Professor of Finance at The Wharton School and WisdomTree’s senior investment strategy advisor. Heather Bell recently chatted with him about what he’ll be addressing in his presentation on the outlook for the market at Inside ETFs, the largest ETF conference in the world, Jan. 24-27.

ETF.com: What are you planning on talking about at the conference?

Jeremy Siegel: I plan to talk about the future path of interest rates, as well as the valuation of equities in the U.S. and around the world and what we can expect as the “new normal.” I also plan to discuss the lack of productivity growth in the world economy and what causes that.

I’m also going to talk about the emerging markets, which have been beaten down dramatically. I think we could see very good returns in three to five years in these markets, but the commodity collapse certainly has been far greater than anyone had anticipated.

One should note that commodities themselves do not have good returns in the long run, so those people who are shocked by the commodities cycle perhaps wouldn’t be if they had looked at long-run data. The long-run return on gold is only about a half a percent per year above inflation, well below stocks and even bonds. I’m going to speak on this issue, and of course Federal Reserve policy in 2016.

ETF.com: Did the commodities boom sort of mislead people?

Siegel: Yes, I think it did. People extrapolate too much from the short run. They look at the last two, three or four years and think, “That’s the way it has to go.” They fail to take a broader look at history, which is much more important than short-run trends.

It’s a human reaction that we get too wrapped up in in the short run. But we have been endowed with a rationality that allows us to step back and look at a longer-term perspective, and when you do that, you are more confident about what the long-term trends are.

ETF.com: I guess it’s that short-term human reaction that makes a good argument for index-based investing, to a certain degree.

Siegel: Yes, or smart index investing—anything that is disciplined and based on sound values. It doesn’t mean shifting in and out of stocks when things “look” good or bad. I think 90% of those traders end up losers.

Obviously at the bottom of the bear market, everyone is the most pessimistic, and at the top of the bull market, everyone is the most optimistic, so if you’re going to follow optimism and pessimism, you’re not going to be a successful investor.

ETF.com: What kind of international exposure should the average investor be aiming for?

Siegel: Half the world’s equity is outside the U.S., and it’s not unreasonable therefore to have approximately half of your equity portfolio in international investments.

ETF.com: So investors’ portfolios should reflect the actual makeup of the world market cap?

Siegel: Basically yes, but you can overweight and underweight regions. I think we might be at a time to overweight the emerging markets right now. They would probably be less than 10% on a market value basis, but 15 or 20% might be called for, for investors with a longer-term perspective that can take the short-term volatility.

ETF.com: How has dividend investing fared in 2015 compared with other years?

Siegel: This is one topic I’m going to talk about at the conference. Dividend investing has fallen a bit behind cap-weighted investing, and I believe much of the reason for that is the fear of interest rate increases. But the interest rate increases are unlikely to be that substantial in 2016, and we could definitely see outperformance of dividend-paying stocks next year.

ETF.com: I’ve seen reports that aging demographics in developed markets are going to translate into lower returns going forward. Do you think that’s likely?

Siegel: I’ve written on this issue, and I believe the biggest source of new equity buying over the next 20 or 30 years is going to come from emerging market investors. As those countries get wealthier, most of them—except for China—will have a younger demographic who are in the acquisition phase of their portfolio planning, and I expect a lot of support in the equity markets from their buying.

It’s very important not to just look at each country’s demographic and say, “Oh their stock market is going up and down because of their aging profile.” We live in a global market. It is global demand that’s going to be critical.

ETF.com: So you don’t think necessarily that an era of lower returns is likely?

Siegel: In a world where we have elevated price earnings ratios—and they’re somewhat elevated now—you will have slightly lower forward-looking real stock market returns. Historically we’ve had about 6.5% returns in stocks in the U.S. after inflation. I wouldn’t be surprised to see it fall to 5 or 6%, but that’s still a very good return.

ETF.com: In the ETF space, factor-based ETFs have been a huge trend, with multifactor ETFs really coming to the forefront this year.

Siegel: As you know, I’m a senior advisor to Wisdom Tree, and we believe in fundamental indexing, and we have quite a few products that are based on the fundamental indexing hypotheses. So I’m currently a supporter of those “smart beta” ETFs.

Now, some factors—like momentum or low volatility or quality—are relatively new, and I’m not convinced they have quite the same persistence as the value criteria that were the original factors that drove these models. But I do think what everyone is beginning to say is that the familiar capitalization-weighted indexes aren’t necessarily the best. A lot of researchers are saying, “I think I can do better.”

ETF.com: Currency hedging is another big trend in ETFs. Is that something you think investors really need to do?

Siegel: Again, Wisdom Tree is one of the leaders in currency-hedged ETFs, and our belief is that, given the interest rate structure around the world, it costs nothing to hedge currency risks between developed economies, so why take that kind of risk if you don’t have to?

We think investors will experience over time a better risk/return trade-off through taking the currency risk off the table, especially now since it costs nothing. We understand if there is a cost to removing currency risk you have to weigh the costs against the benefits, but in our current low-interest-rate environment, it doesn’t cost anything. In fact, with the Fed increasing interest rates, it will pay you to hedge the currency risks, because interest rates will be higher in the U.S.

If you can eliminate a risk and be paid for doing it, that is something I think is an attractive option for investors.

ETF.com: Besides interest rates, what are the risks you’re seeing in the global investment space? Is terrorism one of them?

Siegel: Yes, terrorism is a risk. There is no question about that. A major terrorist attack in a crowded mall or crowded theater—we saw the effect after 9/11—certainly can have a short-run impact. I don’t think it’s going to have a long-run impact, because we recovered from those attacks and we’re a strong people that can move forward from temporary setbacks. But in the short run, clearly it would have an effect. There is always risk around the world.

As I often mention, I remember growing up as a teenager during the Cuban Missile Crisis, where we knew that the Soviet Union had hundreds of nuclear-tipped intercontinental ballistic missiles that were pointed at the major cities in the U.S. and in fact could reach those cities in a matter of hours over the North Pole. That was a frightening situation. We have really had global risks for well over a half century now, and that is a reality.

A lot of people think the risk is a lot greater now, failing to realize that risk has always existed. At the last ETF conference in Amsterdam, we took a trip up the Rhine River, and were told, “This is the longest period of peace between France and Germany in history.” Think about how long wars have been around, and I don’t think those people who say “today we live in a much scarier world” are right.

ETF.com: What do you see ahead for interest rates?

Siegel: I think what we’re going to see is a very moderate rise in interest rates—much, more moderate than the market fears. I don’t see any recession in 2016. And I think that people—because the interest rates are so low and they’re not going to get much higher—will be turning to dividend-paying stocks as the way to provide income in their investment portfolio.

I think that the Fed is going to be very cautious about any further hikes in 2016. I’m not sure whether we will get to 1% by the end of 2016 on the fed funds rate. I certainly do not think that a quarter point that the Fed hiked in December is going to kill the markets or the economy.

ETF.com: What do you think about U.S. fundamentals?

Siegel: We’re the fastest-growing developed country, and although GDP growth has been somewhat disappointing—we are going to get about 2.5% GDP growth next year, and I’m hoping for 3%—we have seen some strong statistics: We brought the unemployment rates down from almost 10% to half that level, and put millions of people to work.

Meanwhile, the rest of the developed world is trying to get back to where it was before the financial crisis. We are well beyond it, and we still have the most flexible labor markets, the most innovative minds and the best entrepreneurs generating ideas, research and new companies. And I think that basic strength of America is still very much with us.

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