http://www.mckinseyquarterly.com/newsletters/chartfocus/2010_07.htm
http://www.nytimes.com/2010/07/18/business/18stra.html?emc=eta1
While many of us are thinking along with Nouriel Roubini that we're headed for a double dip recession, that the next "bubble" will be worse, that we'll be in a very slow GDP growth period (Bernanke) for at least 5 years (with all that implies for unemployment), Jeremy Siegel thinks this is probably a good time to invest. We tend to listen to Siegel because he is the best finance professor on the best finance faculty of any university in the world (Wharton at UPENN).
His position on this situation (quoted in the Times over the weekend, as well as in Knowledge@Wharton on line last week) is pretty much the direct opposite of Robert Prechter's (see our post "Taking Cover," 7/5/10). Prechter is looking at "fractals" and basically predicting the sky is falling. Siegel is looking at the same markets and suggesting that historically lower than average P/E multiples indicate that it's a good time to invest: "there is every reason to believe that (the) mean reversion will continue" - that despite sometimes excruciating declines, the market over the long run will produce average real returns of more than 6% annually. Based on consensus estimates, the P/E is currently at 13. That compares with an annual average of 15.2 since 1945.
If you're looking for optimism, here we go: according to Siegel, prospects for stock investments are excellent. How excellent? There would be a 96.6% probability of a positive return for the next 5 years, going up to 100% for 10- and 20-year periods. Average real returns would be "stellar": about 11% annually in holding periods from 1 to 20 years.
We'll see.
We've attached some data which arrived from McKinsey today on "A Generation of Overoptimistic Equity Analysts." Looking at the last 25 years, equity analysts growth estimates (10% to 12% annually) were way too high. Of course, the actual growth rate for those years was, indeed, the 6% Siegel refers to.
We hope Siegel is right but the uncharted waters that Roubini and others are defining, may not have a precedent. If so, predictions based on past data, may not apply.
Roubini: "The recent crisis has made it clear that the "Great Instability" may be a better description of the coming era than the "Great Moderation" (the years between 1980 and 2007 with low inflation, high growth and mild recessions). Asset bubbles and busts may occur more frequently, and crises once thought to occur only once or twice a century may hammer the global economy more often. Black swans may become white swans." ("Crisis Economics" - Nouriel Roubini/Stephen Mihm - 2010 - The Penguin Press)
It is hard to argue with Roubini.
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I think what Siegel is suggesting makes a lot of sense, that we should be optimistic about the next few years. What we experienced the last two years was essentially a market readjustment that put us back 10 years, in that indexes were at levels similar to 2000. It would be tough for things to keep going down when there is value being created, and we should see mild growth for some time in the markets. This is an entirely qualitative statement though, as I don't have any hard numbers to back that up, just an opinion :)
ReplyDeleteAs for Roubini's comment about instability in the markets, I always seem to come back to our Eisenhower we did on economic growth being correlated to population growth. I think the instability will come from the fact that you (as a company) can't just grow because the world is growing. Instead, you'll see companies come and go faster as they steal or shift market share from one company to another. Think of it like the video rental market, it's not that people are renting more or less movies, it's just that Blockbuster has lost so much market to companies that innovate, such as Netflix and Redbox.
To continue to grow, companies will be forced to push the envelope in creativity and innovation, because true economic growth will only come from staying relevant. I would argue that the days of a company sitting on it's cash cow for 50+ years is over.
I would also say that we should cross our fingers for more political stability in the African continent. It is, without a doubt, the least developed part of the world, and companies would be smart to invest in growing their industries there, because birth rates will probably increase for some time still and death rates will decline rapidly with improving food and health conditions. Putting it simply: it will probably be easier to grow your company in the sense of just having more people to purchase your product in Africa than it would be in more developed areas.
Marcelo: Great comments! Where we're going is probably the low or slow growth scenario that Bernanke has suggested. Part of that growth is going to come from Zakaria's CEOs letting go of some of the "cash" they've been hording to either invest in capital improvements or use for acquisitions. Again, kudos. Your comments should be a blog post!
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