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Shiller vs. Siegel

Contributed by mm | March 8, 2010 7:17 PM PST

6402-bullbear.jpgWall Street Journal published a good article today discussed oppsing views of the market's prospects. What makes it interesting is the two heavyweight scholars that take drastically different sides: Robert Shiller as the bear and Jeremy Siegel as the bull.

Prof. Shiller, whose book "Irrational Exuberance" correctly predicted the .com bubble, and whose name is associated with the monthly housing price index, thinks the market is due for a correction:

Mr. Shiller has compiled market data back to 1881, measuring stock prices month by month relative to corporate profits. To avoid short-term profit distortions, he uses an average of profits over the previous 10 years. Over the long run, by his measure, stocks trade at an average of about 16 times annual corporate profits—that is, their price-to-earnings ratio, or P/E ratio, is about 16.


He has found that when this ratio has gotten above 20, as it is today, it has signaled that the market was expensive and sooner or later would hit a stretch of subpar returns.


The way Mr. Shiller sees it, the problem today isn't just that the current P/E is above 20. It is that since 1991 it has spent only seven months, in late 2008 and early 2009, below the average level of 16. At the start of 2000, it was above 40. No one can say how much longer the P/E can keep rising or when the past year's bull market might end, especially with the government providing heavy stimulus. But past trends, and the law of averages, suggest that at some point the P/E is likely to fall below 16, pulling stocks with it.

Prof. Siegel, the Wharton scholar who boasts the bestsellers like "Stocks for the Long Run," begs to differ:

Mr. Siegel prefers to look at analysts' projections of future earnings, adjusted to exclude special write-offs and charges that he and the analysts think are unlikely to recur.

...

"My research shows that the common P/E is 18.5" when the economy is coming out of a recession, he says. The way he looks at it, the market now is trading at about 14.5 times forecast 2010 profits, making it cheap compared with the typical P/E of 18.5. If stocks rise to 18.5 times profits, the S&P 500 could rise to 1400 this year, a 23% gain from today's level, he notes. "We could easily see 10% to 12% stock returns with low inflation" in future years, he says.

For people who are investing for the future, it's hard not to take sides in this debate. With a very light equity exposure in my portfolio, I am more a fan of Prof. Shiller.

What's your take?

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