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Should You Still Be a Bull?

Contributed by mm | April 4, 2004 8:44 AM PST

Forbes hosted a bear/bull debate between Professor Jeremy Siegel the bull, a Wharton finance professor who wrote the stock Stocks for the Long Run, and Robert Arnott the bear, chairman of First Quadrant, an investment firm managing $18 billion.

While I am a firm bear, I found this transcript informative and interesting in multiple aspects. Some of my take-aways:

On Future Expectation of Stock and Bond Return

Siegel expects 5-6% return on stocks and 0-1% return on bonds over the next five years. Siegel believes on top of the current 1.5% dividend yield, we will see growing economy to add 1 to 1.5 percentage point and the increasing payout rate will bring the dividend yield closer to 5%.

Arnott didn't buy the idea. He thinks the current earning numbers are largely inflated with 25% "fluff" due to optimistic accounting in pension funds and inaction to expense stock options.

Siegel thinks the pension distortion is only on few firms and there is upside in the earning numbers due to inflation creep (inflation eats away the real purchase power of corporate debts), expensing of R&D (which should be capitalized) and conservative GAAP treatment of write-downs.

On P/E Ratio

Siegel mentioned the long-term P/E ratio is 15, which mirrors the 6.7% long-term stock return. Siegel thinks we have upside in the "fair" P/E point because investors can much more easily and cheaply diversify than in the past, which brings less risks. He looks 20 as the reasonable P/E range, which corresponds to his 5% expection for stock return in the future.

Arnott agreed with the notion that we can expect P/E to sit comfortably at 20, but as he firmly believes that the Q4 earning numbers are inflated, he concludes the market is overvalued because it is sitting at 30 times earning now.

On Inflation

Siegel thinks inflation will be 2.5% to 3.0% in the near future, and Arnott is more pessimistic. Arnott thinks the deficit spending and demographic factors (baby-boom entering their golden days) will put upward pressure on goods and services.

On Investment Recommendations For Long Term

Siegel recommends all in stocks with some international exposure. Arnott suggests emerging market and TIPS.

Bonus: Timber Business

Both agreed timber business is an interesting industry: harvested timber is treated as a return of capital until the full acquiring cost of land is fully deducted, this accounting-wise there is basically no cost of sales.

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