Wall Street Yin and Yang
[Sorry, the video for this story has expired, but you can still read the transcript below. ]
PAUL SOLMAN: Economist Jeremy Siegel, whizzing around the go-kart track on the boardwalk of Ocean City, New Jersey. Fellow economist Robert Shiller, however, can’t seem to put his pedal to the metal.
ROBERT SHILLER: I can’t explain it. You know, at some point I just slam on the brakes.
PAUL SOLMAN: Really?
ROBERT SHILLER: Well…
PAUL SOLMAN: You hit the brakes on this?
ROBERT SHILLER: But see, I’m too cautious to just go right into this for the first time and floor it all the way.
PAUL SOLMAN: Yeah, of course you floor it all the way. We’re only going like 15 miles an hour.
ROBERT SHILLER: Well, it’s my personality.
PAUL SOLMAN: Fittingly perhaps, Shiller is the author of the red flag market book Irrational Exuberance, that warned just before the crash of 2000 about the riskiness of stocks. Siegel, on the other hand, helped propel the market boom with his 1994 book Stocks for the Long Run. Dubbed the yin and yang of Wall Street, the two men are actually close friends, who take an annual joint family vacation. We caught up with them this summer to hear what the gurus of risk and caution think about today’s market. Jeremy Siegel, it turns out, has just updated his book, its original message intact.
JEREMY SIEGEL: Over long periods of time– by that, I mean we’re talking about 15, 20 years, 30 years– people planning for retirement, stocks have almost always been their very best asset to hold. And they’ve given a remarkably stable return over long-term periods.
PAUL SOLMAN: Even when you count the crashes, he says, like the one in ’29.
JEREMY SIEGEL: If you were 35 years old, let’s say, in 1929, and you wanted to retire at 65, you got 30 years. You put your money in the stock market right at the peak, or in government bonds, or in treasury bills, and 30 years later, you would be way ahead in the stock market.
ROBERT SHILLER: Well, the other side of it is, you could have gotten out in 1929 and gotten back in in 1932 or something, and then you would have done much better.
JEREMEY SIEGEL: You’d have done fantastically well.
PAUL SOLMAN: Not surprisingly, Shiller still hews closely to the message of his book.
ROBERT SHILLER: We are deflating from the biggest bubble, or maybe the tie for the biggest bubble, since 1929. And this is a major event that makes me nervous about stock market investing. It could either lumber along without going up at all, or go down substantially. So I feel uncomfortable about stocks.
PAUL SOLMAN: So uncomfortable, in fact, that they’re now down to less than 10 percent of his investment portfolio. Siegel, by contrast, has a whopping 80 percent of his money in the market. Their asset allocations aside, Siegel and Shiller actually have a lot in common. Both men, now 56, grew up in the Midwest. Shiller’s father was a mechanical engineer; Siegel’s, the President of a family lumber business. Siegel majored in economics at Columbia, Shiller at the University of Michigan. In 1967, they both went to graduate school at MIT, where they instantly bonded while waiting in line to be tested for TB.
JEREMY SIEGEL: And I’m siegel, "s-I," and Bob is Shiller, "s-H." So we were right together, and our friendship really started in line waiting for our TB X-ray for MIT.
ROBERT SHILLER: Incidentally, that coincidence of the alphabet puts our books together in bookstores. I’ll see them side by side.
JEREMY SIEGEL: That’s right, Shiller and Siegel.
PAUL SOLMAN: By the late 1970s, Shiller and Siegel were vacationing together with their growing families. And it was on one such trip, to the Pocono Mountains in the early ’90s, that Shiller told Siegel his research on long-term stock trends was worth more than an academic paper.
JEREMY SIEGEL: He said, "Jeremy, I think you’ve got a book here. This is interesting stuff."
PAUL SOLMAN: When Siegel’s book came out in 1994, the Washington Post called it "one of the ten best investment books of all time." And when Shiller’s book emerged in March, 2000, with the Dow at 11000, the NASDAQ at 5000, Business Week called it "by far the most important book about the stock market since Stocks for the Long Run." How vindicated do you feel?
ROBERT SHILLER: Well, you never know. It changes from day to day.
JEREMY SIEGEL: As the market was bouncing around so violently in July, Bob and I were talking about the fact that well, one day it’s up tremendously, and I don’t look as bad; then it goes down, and Bob looks better. Who is eventually going to be shown right?
PAUL SOLMAN: So are stocks about to resume their upward climb? Or are they heading for a further fall? Well, that depends in large part on what stocks are really worth right now, which, to economists, depends on corporate profitability.
We’re here on a golf course. Let’s assume that I’m buying a share of the golf course. How do I know if I’m paying a lot or a little for the share of the golf course?
JEREMY SIEGEL: Well, first of all, you have to calculate the profit of the golf course. You have to take all the revenues that they get, subtract off all the expenses from running the golf course, and that’s your profits.
PAUL SOLMAN: Let’s play this out, in graphic detail. Say the course’s profits, after taxes, are $1,000 a year. That’s what I’m theoretically buying, a share of those profits. To keep things simple, let’s say I buy the whole course. If I invest $1,000 for my share, and earn $1,000 in profits that year, the annual return on my investment is 100 percent. If the price of my share is $2,000, that’s $2,000 invested, $1,000 earned, a 50 percent annual return — a price of $10,000, a 10 percent return– and so on. In other words, the higher the price I pay, as a ratio of the earnings, the lower my return. And this so-called Price-to-Earnings ratio, or P/E, is the key measure economists use to gauge how expensive stocks are at any given time. At the height of the market a few years ago, the average P/E of all stocks was up near 50:1. Buying stocks at that price meant investing, on average, $50 for every dollar’s worth of earnings, a 2 percent return. Well, that’s an extremely poor return on my investment.
JEREMY SIEGEL: That’s right.
PAUL SOLMAN: I mean, I could get more than that at a savings account or…
JEREMY SIEGEL: Right. But the second thing is, suppose next year you can sell this golf course at a higher price to someone else?
PAUL SOLMAN: This, of course, was what investors were counting on, sometimes called the "greater fool" theory. Even if economists called you a fool for buying stocks at a price equal to 50 times earnings, you could find a greater fool who’d pay you an even higher price.
JEREMY SIEGEL: Wow, that looks like IPOs during the bubble years. It used to go up 200 percent, 300 percent on the first day.
PAUL SOLMAN: But you didn’t invest in the Internet stocks.
JEREMY SIEGEL: I did not go into any Internet stocks, not one.
PAUL SOLMAN: Maybe earnings would soar in the future, justifying that stratospheric price. Maybe people couldn’t see anywhere else to invest their money, and were simply going with the flow.
ROBERT SHILLER: But eventually, the market is supported by expectations that can’t be continually fulfilled, so eventually when the market stops going up, then the… then people don’t see their expectations fulfilled, and they want to sell. And then, when they sell, the market starts to dip, and that generates more desire for selling, eventually into a crash where the market… where everybody is selling at once, and the price falls dramatically.
PAUL SOLMAN: But the price fell, and then it rose again just recently.
ROBERT SHILLER: Yes, because the human dynamics is very complicated, the bubble-burst metaphor was misleading, because the bubble can inflate again at any time.
PAUL SOLMAN: But to Shiller, the trend was obvious. In the ’90s, the divergence between the price of companies and their earnings grew increasingly out of whack. To Siegel, however, the long run trend was what mattered. There have got to be people in our audience who bought your book and bought stocks on the basis of it, and now say, "what did I do? What did this guy mislead me into doing?"
JEREMY SIEGEL: Yeah. Well, if they bought in March of 2000, yes, they are very unhappy.
PAUL SOLMAN: And unhappy with you.
JEREMY SIEGEL: Yeah, and unhappy with me. But no one said that we banished bear markets. I mean, you know, I didn’t say that there wouldn’t be short periods of time when you can suffer a really bad shock, and that’s what we had! We had a big upsurge, much of which wasn’t justified, and then we had a down surge. And I think right now it’s rewarding, looking forward in the stock market. Hang in there. Don’t sell when everyone’s discouraged about stocks and everyone’s gloomy. That’s usually the best time to actually keep your portfolio and buy stocks.
PAUL SOLMAN: So, in general, Siegel advises buying into a bear market. Yes, he admits, the current overall market Price-to-Earnings ratio is still 20-something to one, by the most conservative reckoning, while the historical average is closer to 15:1. But, says Siegel:
JEREMY SIEGEL: I think the markets have changed. I think the Price/Earnings ratio actually should be somewhat higher, not the way it was. But my feeling is the low 20s is a very justifiable level of the stock market, given the low inflation, low transactions cost, and ease with which people can diversify their portfolios today. These were not present all the time, during the last 130 years or 50 years.
PAUL SOLMAN: Naturally, Bob Shiller disagrees. He believes today’s P/E ratio is still too high, by as much as 50 percent.
ROBERT SHILLER: Even if it is at the right level, there’s a chance for it to go down below as the bubble continues to unravel, and I see psychology changing in an increasingly negative direction. So I think that there is a lot of downside potential now.
PAUL SOLMAN: To Shiller, that is, psychology is as important as the P/E ratio, a point poignantly demonstrated on the go-kart track.
PAUL SOLMAN: Are you a lot less of a daredevil than he is?
ROBERT SHILLER: I get the jitters. I can’t… I have to relax and enjoy life, you know? I can’t… I don’t like the stimulus that drives Jeremy.
PAUL SOLMAN: Do you think that that could at all explain the differences in your investing philosophies?
ROBERT SHILLER: Oh, absolutely. I want to be able to sleep at night. Ultimately, you have to feel good about your investments.
SPOKESMAN: Final lap. Go.
PAUL SOLMAN: In the end, then, if there’s a moral to draw from the Shiller/Siegel debate, it may simply be this: The best investment strategy is the one that fits best with your own personality.