Stocks, Bonds and Future ReturnsProf. Jeremy J. Siegel ~ The Wharton School

Jacobs Levy Center Conference ~ September 14, 2018

Past performance is not indicative of future results. For Financial Professional Use Only

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Historical Total Real Return Indexes

STOCKS$1,372,018

BONDS$1599

BILLS$263

GOLD $3.09

DOLLAR $0.048

$0.01

$0.1

$1.

$10.

$100.

$1,000.

$10,000.

$100,000.

$1,000,000.

$10,000,000.

1802 1811 1821 1831 1841 1851 1861 1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011

January 1802 – June 2018

Stocks: 6.7% RealBonds: 3.5% RealBills: 2.6% RealGold: 0.5% RealDollar:-1.4%Real

Past performance is not indicative of future results.

Source: Siegel, Jeremy, Stocks for the Long Run (2014), With Updates to 2018

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P-E Ratio on S&P 500 , 1954-2018

Double Digit Interest Rates

Median PE over period = 17.07

Source: Bloomberg 12/31/1954-5/5/16

PE 30

You cannot invest directly in an index

Past performance is not indicative of future results. For Financial Professional Use Only

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Definitions of S&P 500 Earnings

§ Firm Reported: Most liberal, excludes asset impairments, severance costs, Cash plant closing costs, litigation expense, pension value changes, and stock option expenses; 2017 $133.12; Est. 2018 $162.79, Est. 2019 $179.32.

§ S&P Operating: Excludes some asset impairments (except for financials) and severance costs; 2017 = $124.51 Est. 2018 = $157.79, Est. 2019. $177.00.

§ GAAP: Mandates write-downs and asset impairments, whether sold or not; Does not permit “write-ups” unless asset sold. 2017= $109.88; Est. 2018 = $142.99; Est. 2019 = $163.51

§ Warren Buffet, in 2017 Annual Report, said new mark-to-market rules make GAAP earnings, for analytical purposes, “useless.”Past performance is not indicative of future results. For Financial Professional Use Only

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What do PE Ratios Mean for Returns?§ Earning Yield (E/P) is good predictor of long-term real returns. § Over past 140 years, P-E ratio averaged about 15, which

corresponds to 1/15, or 6.7% E/P, or real return on stocks.

§ With S&P at 2871 (Sep 7), stocks are selling for about 18 times 2018 and 16.1 times 2019 estimated operating earnings.

§ A PE ratio of 18 forecasts a real return of 5.5% for stocks (or about 7.5% nominal return with 2% inflation). This is more than 4 ½ percentage points over Treasury bonds, a margin economists call the “equity risk premium.” This premium is also above the historical average of 3% to 3 ½%.

§ 5.5% real returns comprised of 2% dividend, 3.5% real EPS growth (2.5% of which caused by buybacks).

§ Warranted P-E ratio is higher than historical average because of virtually zero cost of indexing, allowing investors to receive far superior risk return trade-offs.

Source: S&P 1/18/18You cannot invest directly in an index

Past performance is not indicative of future results. For Financial Professional Use Only

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What is “warranted” Equity return?

§ Indexed return over 19th and first half of 20th

century 6.7% real.

§ But few, if any investors were able to achieve that net of transactions costs (brokerage plus bid/ask spreads).

§ Cost of maintaining cap-weighted portfolio likely 150 bps per year or more in earlier period, leaving a net real return of about 5%.

§ Today cost of indexation is virtually zero. An 18 P-E ratio, leading to a 5.5% real return, can be regarded as the “new normal” equity return.

§ Record low real interest rates, could push equilibrium P-E ratio even higher.

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Lower Payout Ratio = Higher EPS Growth

Reported Real EPS Growth

Real Dividend Growth

Dividend Yield

Real Capital Gains

Real Stock

Returns

Payout Ratio

1871-2018 1.96% 1.56% 4.34% 2.36% 6.94% 61.5%1871-1945 0.67% 0.74% 5.31% 1.32% 6.84% 70.8%1946-2018 3.30% 2.42% 3.35% 3.44% 7.05% 51.5%

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Shiller CAPE ratio

§ In 1996. Robert Shiller, with John Campbell, both at Yale, devised a “Cyclically Adjusted P-E ratio” to judge valuation of the market.

§ Shiller averaged past 10 years of (real) per share GAAP earnings on market index portfolio to compute his PE ratio.

§ P-E ratio in August 2018 is about 32, based on GAAP earnings, nearly double the 140-year mean value of the series.

§ CAPE methodology forecasts forward 10 year real returns on stocks of only 2.6%, about 40% of long-run average (but still more than bonds).

FOR FINANCIAL PROFESSIONAL USE ONLY

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Shiller CAPE Ratio: Reported and Operating

Source: Siegel, “The Shiller CAPE Ratio: A New Look” May 2016, Updated

0.00

10.00

20.00

30.00

40.00

50.00

1881

1885

1889

1894

1898

1902

1907

1911

1915

1920

1924

1928

1933

1937

1941

1946

1950

1954

1959

1963

1967

1972

1976

1980

1985

1989

1993

1998

2002

2006

2011

2015

CAPE Avg CAPE

Overvalued

Undervalued

31.9

Mean = 16.9

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Shiller CAPE Ratio: Reported and Operating

Source: Siegel, “The Shiller CAPE Ratio: A New Look” May 2016, Updated

0.00

10.00

20.00

30.00

40.00

50.00

1881

1885

1889

1894

1898

1902

1907

1911

1915

1920

1924

1928

1933

1937

1941

1946

1950

1954

1959

1963

1967

1972

1976

1980

1985

1989

1993

1998

2002

2006

2011

2015

CAPE Avg CAPE Operating CAPE

Overvalued

Undervalued

31.9

Mean = 16.9

27.5

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1871

1876

1881

1886

1891

1896

1901

1906

1911

1916

1921

1926

1931

1936

1941

1946

1951

1956

1961

1966

1971

1976

1981

1986

1991

1996

2001

2006

2011

2016

Log

Earn

ings

Real Per Share Reported Earnings

Great Depression

Source: “The Shiller CAPE Ratio: A new Look” J. Siegel May 2016Past performance is not indicative of future results.

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1871

1876

1881

1886

1891

1896

1901

1906

1911

1916

1921

1926

1931

1936

1941

1946

1951

1956

1961

1966

1971

1976

1981

1986

1991

1996

2001

2006

2011

2016

Log

Earn

ings

Reported Operating NIPA

Real Reported, Operating and NIPA Earnings

Great Depression

Source: “The Shiller CAPE Ratio: A new Look” J. Siegel May 2016Past performance is not indicative of future results.

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CAPE Ratio Relative to Long-term MeanShiller Total Return Portfolio 1987-2018

Source: “The Shiller CAPE Ratio: A new Look” J. Siegel May/June 2016, Updated

0.50

1.00

1.50

2.00

2.50

1987

1988

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2010

2011

2012

2013

2014

2015

2016

2017

2018

Reported Operating NIPA

RPT: 1.71

OP: 1.53

NIPA: 1.36

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Shiller CAPE Ratio: Forecast 3.5% real EPS growth

Source: Siegel, “The Shiller CAPE Ratio: A New Look” May/June 2016, Updated

Overvalued

Undervalued

23.8

Mean = 17.521.5

0

10

20

30

40

50

1881

1885

1889

1893

1897

1901

1906

1910

1914

1918

1922

1926

1931

1935

1939

1943

1947

1951

1956

1960

1964

1968

1972

1976

1981

1985

1989

1993

1997

2001

2006

2010

2014

2018

2022

2026

CAPE Avg CAPE Operating CAPE

Forecast:3.5% real EPS Growth

21.5 CAPE consistentWith 18 P-E ratio and5.5% real equity return

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Published May/June 2016 FAJ