Future for Investors Prof. Jeremy J. Siegel ~ The Wharton School Boston Security Analysts Society ~ December 5, 2005

Future for InvestorsProf. Jeremy J. Siegel ~ The Wharton School

Boston Security Analysts Society ~ December 5, 2005

Copyright Jeremy J. SiegelStocks for the Long Run and Future For Investors by Jeremy J. Siegel2

The Verdict of History


STOCKS$632,680

BONDS$1115

BILLS

$292

GOLD$1.38

DOLLAR$0.06

$0.01

$0.1

$1.

$10.

$100.

$1,000.

$10,000.

$100,000.

$1,000,000.

1801 1811 1821 1831 1841 1851 1861 1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001

January 1802 – June 30, 2005

Total Real Return Indices


Annual Stock Market Returns

Real Returns

Long-Term

1802-2005 6.8%

Major Sub-Periods

I 1802-1870 7.0%II 1871-1925 6.6%III 1926-2005 6.7%

Post-War Periods

1946-2005 6.8%1946-1965 10.0%1966-1981 -0.4%1981-1999 13.6%1984-2005 8.9%

Updated through June 30, 2005


Annual Bond Market Returns

Real Returns

Long-Term

1802-2005 3.5%

Major Sub-Periods

I 1802-1870 4.8%II 1871-1925 3.7%III 1926-2005 2.3%

Post-War Periods

1946-2005 1.5%1946-1965 -1.2%1966-1981 -4.2%1981-1999 8.4%1984-2005 7.2%

Updated through June 30, 2005


Long and Short-term Risk of

Stocks and Bonds


Holding Period Risk for Annual Real Returns

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1 2 5 10 20 30

Holding Period

Risk

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Actual Stocks

Actual Bonds

Actual Bills

Historical Data and Random Walk (Dashed Line)1802 – 2004


Projected Equity Returns

Earnings Yield, or 1/P-E ratio, is excellent long-term predictor of real stock returns.

Average P-E ratio in last 130 years = 15; average earnings yield 6.7%.

S&P 500 Estimate of next 12 months operating earnings $85.55 (end 4Q06)

S&P 500 (Nov. 30) = 1258. P-E ratio 14.70, earning yield = 6.80%.

If you take reported earnings, estimate $77.90, for a P-E ratio of 16.15, EY of 6.19%

If you take core earnings estimate $72.57, P-E ratio 17.33, earnings yield 5.77%


Bond Returns and Equity Premium

Ten year at 4.47%, 30-year at 4.68%

If we subtract 2.5% for inflation, we get a real yield of 1.97% and 2.18%.

TIPs yields are 2.11% and 2.07%.

Equity Premium is about 4% now.

Expect real yields to rise about 1%

Long-Term Equity Premium = 3%.


Rationale for Lower Equity Returns

Greater Liquidity and ease of diversification in the equity Market

Greater understanding by investors of the equity premium.

Increasingly favorable taxation of equity.


The Future for Investors


What Happened to the

Original S&P 500

Formulated in 1957?


Is Updating Essential to indexed Returns?

Richard Foster and Sarah Kaplan from McKinsey & Co, in their 2001 book, Creative Destruction state (p. 28):

“New companies generate higher levels of total return to shareholders than do the older survivors. …. For example if the S&P 500 were today made up of only those companies that were on the list when it was formed in 1957, the overall performance would have been significantly less.”


Change in Sector Weights 1957-2005

Financials

Health Care

Information Tech

Consumer Staples

Telecom Svc

Utilities

Industrials

Consumer Discretionary

Energy

Materials

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%19

57

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


S&P 500 Portfolios

Original S&P 500 Firms500

Survivors’ Portfolio

125

+ Merged Firms92

+ Reissued From Privatization

11

=Direct Descendants

Portfolio228

+ Spin-offs111 =

Total Descendants Portfolio

339


Value 11.31% 15.72% 0.4343

Equal 12.28% 18.45% 0.4446Survivors Portfolio

Value 11.35% 15.93% 0.4331

Equal 12.18% 18.55% 0.4375Direct Descendants

Performance of Portfolios (1957-2003)

Where did Foster and Kaplan go wrong?

Confused Return and Market Value

Portfolio Initial Weighting Return RiskSharpe Ratio

S&P 500 Value 10.85% 17.02% 0.3871

Value 11.40% 16.08% 0.4338

Equal 12.15% 18.53% 0.4360Total Descendants

New Stocks in S&P 500 often overpriced: Indexing and bubbles


Twenty Top Performing SurvivorsReturn Rank 2003 Name Return EPS Gr

Avg PE Ratio

Dividend Yield

1 PHILIP MORRIS COS INC 19.75% 14.64% 13.15 4.07%2 ABBOTT LABS 16.51% 12.43% 21.26 2.25%3 BRISTOL MYERS SQUIBB CO 16.36% 13.24% 23.64 2.87%4 TOOTSIE ROLL INDS INC 16.11% 9.09% 16.54 2.44%5 PFIZER INC 16.03% 10.94% 24.55 2.45%6 COCA COLA CO 16.02% 10.57% 27.40 2.81%7 MERCK & CO INC 15.90% 13.11% 25.54 2.37%8 PEPSICO INC 15.54% 9.57% 20.38 2.53%9 COLGATE PALMOLIVE CO 15.22% 7.84% 21.66 3.39%10 CRANE CO 15.14% 6.93% 13.28 3.62%11 HEINZ H J CO 14.78% 11.00% 15.30 3.27%12 WRIGLEY WILLIAM J R CO 14.65% 7.49% 18.11 4.02%13 FORTUNE BRANDS INC 14.55% 4.26% 12.76 5.31%14 KROGER COMPANY 14.41% 6.25% 14.31 5.89%15 SCHERING PLOUGH CORP 14.36% 11.99% 21.41 2.57%16 PROCTER & GAMBLE CO 14.26% 9.20% 24.27 2.75%17 HERSHEY FOODS CORP 14.22% 7.36% 15.75 3.67%18 WYETH 13.99% 8.78% 20.98 3.32%19 GENERAL MILLS INC 13.77% 8.23% 18.00 3.20%20 ROYAL DUTCH PETROLEUM CO 13.64% 7.65% 12.52 5.24%

TOP 20 Average 15.26% 9.53% 19.04 3.40%

S&P 500 10.85% 5.98% 17.35 3.27%


Top Twenty on November 30

Est PE Next Yr P-E Divd YieldMO 14.29 13.26 4.19ABT 15.17 14.11 2.88BMY 15.48 17.44 5.17TR 23.30 21.88 0.94

PFE 11.01 10.57 3.56KO 19.88 18.71 2.58

MRK 11.88 12.62 5.18PEP 22.56 20.40 1.69CL 20.77 18.72 2.09CR 14.16 12.86 1.45

HNZ 14.92 14.23 3.40WWY 28.37 25.38 1.55

FO 17.14 14.64 1.76KR 15.11 13.40 0.00

SGP 53.82 32.71 1.13PG 22.27 19.28 1.96

HSY 23.21 20.78 1.65WYE 14.29 13.37 2.24RD 9.61 9.46 3.77GIS 16.55 15.35 2.75

Average 19.19 16.96 2.50Ave X SGP 17.37 16.13 2.57S&P500 18.46 16.41 1.78


Consumer Discr

Consumer Staples

Energy

Financials

Health Care

Industrials

Info Tech

Materials

Telecom SvcUtilities

S&P 500

y = 0.0753x + 0.1095

R2 = 0.3187

0%

2%

4%

6%

8%

10%

12%

14%

16%

-30% -25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25%

Sector MV Change ReturnConsumer Discr -3.28% 11.09%Consumer Staples 5.23% 13.36%Energy -15.68% 11.32%Financials 19.87% 10.58%Health Care 12.14% 14.19%Industrials -1.13% 10.22%Information Tech 14.71% 11.39%Materials -23.06% 8.18%Telecom Svc -4.00% 9.63%Utilities -4.81% 9.52%

S&P 500 Sector Market Value Expansion versus Total Return

Growth Does Not Guarantee Return

*

Info Tech EX-IBM(16.2%,10.6%)


Is there a “Corporate El Dorado”?Quotation from Foster and Kaplan’s Creative

Destruction: p. 9 “McKinsey’s long-term studies of corporate birth,

survival, and death in America clearly show that the corporate equivalent of El Dorado, the golden company that continually performs better than the markets, has never existed (emphasis theirs). It is a myth.”

Top Performing Stock From 1925-2004– Philip Morris, Return 17.36% vs. 10.04% Market.

Top Performing Stock From 1950– Philip Morris, Return 17.87% vs. 11.47% Market.

Top Performing Stock from original S&P 500 in 1957– Philip Morris; Return 19.72% vs. 10.86% for S&P 500.

$1,000 put in S&P 500 when it was founded would turn into $138,549 by the end of 2004.

$1,000 put in Philip Morris at the same time would grow to over $5.5 million.


Dividend Yield and Relative Performance

$ 72,068

Low Div Yield

$ 82,341 $113,894

$351,581

High Div Yield

$517,188

$144,996 S&P 500

$1,000

$10,000

$100,000

$1,000,000

19

57

19

59

19

61

19

63

19

65

19

67

19

69

19

71

19

73

19

75

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

Dividend Yield Return Risk

Highest 14.22% 19.09%High 13.28% 16.49%

Middle 10.60% 16.35%

Low 9.84% 18.57%Lowest 9.53% 23.52%

S&P 500 11.17% 16.84%


The Aging of the Population

The Most Critical Long-term Economic

Issue Facing the Developed World

The Next Fifty Years


Long Term Demographic Trends

U.S. Life Expectancy and Retirement Age

56

60

64

68

72

76

80

1950-1955

1955-1960

1960-1965

1965-1970

1970-1975

1975-1980

1980-1985

1985-1990

1990-1995

1995-2000

Life Expectancy

Retirement Age

Past marked by (1) rising life expectancy and (2) falling Retirement Age

But this trend Cannot Continue

1.6 Years 14.4 Years


Age Wave -- US


Age Wave – Japan


Big Questions

The Biggest Questions Facing the Developed

World

Who Will Produce the Goods?

Who Will Buy the Assets?


Retirement Age must rise to 73


Life Expectancy

Retirement Age

56

60

64

68

72

76

80

84

88

1950

-195

5

1955

-196

0

1960

-196

5

1965

-197

0

1970

-197

5

1975

-198

0

1980

-198

5

1985

-199

0

1990

-199

5

1995

-200

0

2000

-200

5

2005

-201

0

2010

-201

5

2015

-202

0

2020

-202

5

2025

-203

0

2030

-203

5

2035

-204

0

2040

-204

5

2045

-205

0

`

14.4 Years

9.2 Years


Productivity Growth and Retirement

Can faster productivity growth help the Aging Problem?

Let us be extraordinarily optimistic and assume future productivity growth averages 3 ½ % per year, 70% above long term average of 2.2%.


3.5% Productivity reduces retirement age 2-3 years


Life Expectancy

Retirement Age

3.5%Productivity

56

60

64

68

72

76

80

84

88

`


Immigration?

The number of immigrants to the US over the next 45 years needed to keep the retirement age in the mid 60s would be about one-half billion, far in excess of the current population.


But there is Hope

Outside the developed countries, the population of the world is much younger.

Let’s look at India.


Age Wave -- India


Trade Deficits and Aging

Throughout history, the “old” have sold assets to the young in exchange for goods.

Today in US, Florida’s retirees sell assets to and import goods from other 49 states.

In the future the US will sell its assets to the rest of the world.

Success depends on rapid growth in the developing world.

Western Europe 6.41%

U.S.4.68%

Low Income13.64%

Mid Income5.63%

Eastern Europe5.02%

Latin Am/Carib

8.57%

India16.66%

China21.05%

Hi Inc. nonOECD

1.12%

Canada0.51%

Aus / NZ0.38%

Japan2.10%

Sub-Saharan

Africa10.74%

Indonesia3.50%

World GDP 2000Population 2000

84.8%

15.2%

Western Europe

21%

U.S.22%

Low Income5%

Mid Income5%

Eastern Europe

5%

Latin Am/Carib

8%

India5%

China11%

Hi Inc. nonOECD

4%

Canada2%Aus / NZ

1%

Japan8%

Sub-Saharan

Africa2%

Indonesia1%

44.6%

56.4%

Examples of High Income Non-OECD countries: Singapore, Hong-Kong, Israel, Saudi Arabia

Mid Income Countries: Turkey, South Africa, Phillipines, Iran, Malaysia

Low Income Countries: Pakistan, Bangladesh, Nigeria

Examples of Eastern Europe: Russia, Poland, Ukraine

Western Europe

6%

U.S.11%

Low Income10%

Mid Income6%

Eastern Europe

3%

Latin Am/Carib

11%

India16%

China20%

Hi Inc. nonOECD

3%

Canada1%

Aus / NZ1%

Japan2%Sub-

Saharan Africa

7%

Indonesia3%

23.1%

76.9%

Population 2050 World GDP 2050






U.S.4.26%

Low Income17.38%

Mid Income5.54%

Eastern Europe2.39%

Latin Am/Carib

8.64%

India16.86%

China15.68%

Hi Inc. nonOECD

1.32%

Canada0.43%

Aus / NZ0.33%

Japan1.17%

Sub-Saharan

Africa18.88%

Indonesia3.34%

11.8%

88.2%

0% 20% 40% 60% 80% 100%

U.S.

Western Europe

Japan

Canada

Aus / NZ

Hi Inc. nonOECD

China

India

Latin Am/Carib

Eastern Europe

Mid Income

Low Income

Sub-Saharan Africa

Indonesia

Per Capita IncomeRelative to US 2000


0% 20% 40% 60% 80% 100%

U.S.

Western Europe

Japan

Canada

Aus / NZ

Hi Inc. nonOECD

China

India

Latin Am/Carib

Eastern Europe

Mid Income

Low Income

Sub-Saharan Africa

Indonesia

8.05%

7.35%

12.83%

11.50%

100.00%

0% 20% 40% 60% 80% 100%

US

Hong Kong,China

Japan

South Korea

Singapore



100.00%

47.84%

65.18%

74.46%

72.36%

0% 20% 40% 60% 80% 100%

US

Hong Kong,China

Japan

South Korea

Singapore


Retirement Age with high growth in LDCs


Life Expectancy

Retirement Age Developing

Countries High Growth

56

60

64

68

72

76

80

84

88

1950

-195

5

1955

-196

0

1960

-196

5

1965

-197

0

1970

-197

5

1975

-198

0

1980

-198

5

1985

-199

0

1990

-199

5

1995

-200

0

2000

-200

5

2005

-201

0

2010

-201

5

2015

-202

0

2020

-202

5

2025

-203

0

2030

-203

5

2035

-204

0

2040

-204

5

2045

-205

0

`


The Global Solution

The answer to our question: Who will produce our goods?

Who will buy our assets?

Is the same:The Developing Countries

By the middle of this century Developing Countries will

own most of world’s capital.

Developed Economies will run increasing trade DeficitsTrade Deficits will be demographically determined



U.S.41.21%

Low Income0.53%

Mid Income0.53%

Eastern Europe1.14%

Latin Am/Carib

2.00%

India1.90%

China1.19%

Hi Inc. nonOECD

5.30%

Canada2.99%

Aus / NZ2.08%

Japan14.82%

Sub-Saharan

Africa0.38%

Indonesia0.03%






U.S.16.59%

Low Income6.37%

Mid Income5.56%

Eastern Europe3.43%

Latin Am/Carib10.62%

India14.06% China

20.33%

Hi Inc. nonOECD

3.15%

Canada1.11%

Aus / NZ0.72%

Japan2.64%

Sub-Saharan

Africa4.23% Indonesia

2.36%

Stock Market Capitalization 2000

7.7% 92.3% 33.0%

67.0%

Stock Market Capitalization 2050


Growth and Stock Return in Emerging Markets

Emerging Markets

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

-2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

Total Real GDP Growth

Do

llar

Ret

urn

China

CountryGDP

GrowthStock

Returns

Singapore 6.91% 5.23%Malaysia 6.75% 6.39%Korea 6.18% 4.66%Thailand 5.92% 6.41%Chile 5.90% 19.33%Indonesia 4.85% 5.84%Hong Kong 3.97% 10.77%Philippines 3.67% 2.09%Turkey 3.30% 10.02%Portugal 2.96% 3.71%Jordan 2.93% 3.88%Mexico 2.93% 22.31%Greece 2.73% 12.39%Brazil 1.80% 18.46%Argentina 1.40% 17.71%China* 9.30% -9.85%India* 6.06% 6.51%Sri Lanka* 4.52% 2.04%Poland* 4.42% 16.63%Peru* 4.32% 14.61%Israel* 3.67% 4.98%Pakistan* 3.45% 4.60%South Africa* 2.59% 10.47%Colombia* 2.22% 5.16%Venezuela* -1.03% 3.95%S

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and

GD

P D

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Fro

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1992

thr

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200

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P D

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987

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20

03


Projected Trade Surpluses and Deficits

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050US -0.2% -1.0% -2.0% -3.2% -4.6% -5.5% -5.0% -4.2% -3.6% -3.4%Europe -1.5% -2.7% -3.5% -4.2% -5.3% -7.2% -8.5% -9.1% -9.3% -9.0%Japan -4.8% -9.7% -12.7% -13.3% -12.6% -12.3% -13.0% -15.7% -18.8% -20.3%China 1.4% 2.3% 2.3% 1.9% 1.9% 1.4% -0.1% -1.3% -1.3% -0.6%India 2.2% 3.8% 4.9% 5.6% 5.9% 6.3% 6.3% 6.1% 5.7% 5.2%Eastern Europe 2.3% 3.4% 2.4% 0.3% -1.5% -2.3% -2.9% -5.1% -8.9% -12.8%Hi Inc. nonOECD -1.5% -3.0% -4.0% -5.2% -6.3% -6.9% -7.3% -7.9% -8.7% -9.5%Latin Am/Carrib 1.8% 2.8% 3.4% 3.5% 3.3% 2.9% 2.4% 1.5% 0.3% -0.5%Mid Income 1.8% 3.0% 3.6% 3.8% 3.8% 3.6% 3.3% 2.5% 1.3% 0.1%Indonesia 2.5% 4.4% 5.5% 5.8% 5.7% 5.2% 4.3% 3.2% 1.9% 1.1%Sub-Saharan Africa 2.9% 5.1% 6.7% 8.0% 9.1% 9.9% 10.4% 10.7% 10.5% 10.3%Low Income 3.1% 5.2% 6.3% 6.7% 6.9% 6.9% 6.9% 6.6% 5.9% 5.2%

Trade Surplus/ Deficit Percent of GDP


Conclusions

I believe that growth in developing world will offset slowing in aging economies and support future equity prices.

Do not jump into emerging markets without examining valuation.

Forward looking real returns on US stocks 5½% to 6½%, about one percent below long term historical average.

These returns are far above what can be expected in bonds or even real estate.


Visit JeremySiegel.com

Documents

Future for Investors Prof. Jeremy J. Siegel ~ The Wharton School Boston Security Analysts Society ~ December 5, 2005