Jeremy Siegel wrote one of the ten most important investing guides ever written, Stocks for the Long Run. All those seeking to attain financial freedom early in life would do well to read it. I haven’t read his later book, The Future of Investing. but my understanding is that it argues in favor of investing in stocks that pay high dividends. That’s good advice. So there’s a lot that I like about Jeremy Siegel.
That said, I believe that Jeremy Siegel is a truly dangerous individual. Here’s why.
Jeremy Siegel is dangerous because he is the single individual most responsible for the out-of-control bull market of the 1990s
If you are a regular reader, you know that I am not a fan of bull markets. Bull markets destroy middle-class wealth (not immediately, to be sure, but down the road that’s always their ultimate effect). Jeremy Siegel developed an approach to stock analysis of such great power that it played a significant role in fueling the most out-of-control bull market in U.S. history. Now, that’s some dangerous stuff!
What Jeremy Siegel did was to make investing analysis scientific. Too many investing claims are subjective in nature. People hear six different “experts” giving six different viewpoints that all conflict with each other and have no idea what to make of it all. Jeremy Siegel cut through the nonsense by looking to something objective to make his points — the historical stock-return data. Many looked at the data before Siegel came along, of course. But he did so in an exhaustive way, giving added power to all his findings by setting them forth in a book that appeared to evidence a deep and complete understanding of the objective realities.
Investors want to believe in bull markets. Their common sense tells them to hold back, that the story being told is too good to be true. But there’s a weakness in human nature that makes us all want to believe in the Get Rich Quick scheme. At the time when Siegel’s book came along, the early 1990s, many investors were already inclined to listen to the devil whispering in their ears. They needed some sort of authoritative rationalization to justify doing so. Siegel gave it to them. Siegel is the dealer who got us hooked on the nasty drug that caused the ugliest price run-up ever.
I don’t think he meant to do this. Siegel is a human like all the rest of us. He got caught up in the enthusiasms of the moment for the same reasons that caused many others to do so. He sampled the drug himself before he started pushing it on us. Still, he played a big role. If you like bull markets (what are you doing here? — just kidding!), you need to give Siegel credit. If you hate them (comrade!), he’s one of the figures on which you need to pin the most blame.
Jeremy Siegel is dangerous because he takes the Efficient Market Theory seriously.
The Efficient Market Theory assumes (there’s a big difference between assuming something and showing it to be so) that investing is primarily a rational endeavor. Honey, we forget the people! So long as stocks are owned by humans, stock investing will remain primarily an emotional endeavor. Jeremy Siegel rooted his research in a false premise.
The result is that most of what he says about stocks is both important (because it really is critical to mine the historical data for objective insights) and wrong (because Siegel’s approach ignores the reality that the human owners of stocks at times bid their prices up to absurdly “inefficient” levels).
The best example of this is Siegel’s assertion that: “The superiority of stocks to fixed-income investments over the long run is indisputable.” There’s an important investing truth being conveyed here. It really is so that investors who commit to holding stocks for the long run greatly diminish the risks associated with them by doing so. No one has made this point more effectively than Siegel, and he deserves great credit for having done so. Still, the assertion is ultimately a half-truth. It is as much in error as it is accurate.
To understand why, you need to see why it is that holding stocks for the long run diminishes their risk. It is because stock prices become far more predictable in the long run. Stocks are risky in the short run because you have little idea what your stock investment is going to be worth in the short run. In the long run, you can know, at least to a reasonable extent. But making stock prices predictable by holding them for the long run does not always render stocks a “superior” investing class. What happens when long-term stock returns are predictably poor (because prices are too high)? In those circumstances holding for the long term renders stocks an inferior choice, not a superior one.
It is Siegel’s belief in the Efficient Market Theory that caused him to miss this. He looked at the returns provided by stocks over the very long term (30 years and longer), saw how wonderful they are, and concluded that stocks are superior. In the real world, investors need to see some evidence of good performance within 10 years or so or they give up on their stocks and end up selling at the worst possible time. When stock prices are high (as they are today — this article was posted in July 2007), the likely 10-year return on stocks is poor compared to what can be obtained from far safer investment classes. For those able to wait at least 10 years to see a good return but perhaps not much longer, stocks are very much an inferior investment choice today.
If the market were efficient, it would not be possible for stocks ever to be bid up to such absurd levels as they were in the late 1990s. The market really is inefficient. The late 1990s really did happen. Siegel got it wrong. Stocks are sometimes inferior.
Jeremy Siegel is dangerous because he takes too much comfort from his worst-case-scenario finding.
There’s a sentence in Jeremy Siegel’s book in which the truth about the long-term risk of holding stocks purchased at high prices almost hits him in the face. He says: “The fact that stocks, in contrast to bonds or bills, have never offered investors a negative real holding period return yield over periods of 17 years or more is extremely significant.”
He means for that to be reassuring. Viewed with a brain cleared by some distance from the madness of the 1990s, it’s not so comforting. It is asking an awful lot of stock investors to expect them to be able to wait 17 years to see even a penny of positive return. I’ve communicated with thousands of middle-class investors on discussion boards. Most are not able even to imagine the possibility that it could take them 17 years to obtain the first penny of return on their stocks.
I wish that Jeremy Siegel had worded things differently. I wish that he had said: “The historical data shows that there is a real possibility that you may need to wait 17 years just to break even on your stock investment — be careful out there.” Putting it that way wouldn’t have stopped the bull market in its tracks. Perhaps it would have slowed it down a bit. Slowing it down a bit would have been the more responsible thing to do.
Jeremy Siegel is dangerous because his worst-case scenario number is calculated improperly.
It’s not just that Jeremy Siegel took some bad news (that there is already an instance on the record in which it has taken stock investors 17 years to break even on their investment) and phrased it in such a way as to make it sound like good news. The reality is that the 17-year number is by no means the true worst-case scenario.
There have only been two times in modern stock-market history that we have been at the sorts of valuation levels where we have been since the mid-1990s. In one of those cases, it took 17 years for stock investors to break even. Does the fact that in two spins of the wheel we have already seen a case in which it took 17 years to break even show that it is unlikely that it will take more than 17 years to break even on the third spin of the wheel? By no means! Determine the worst-case-scenario using an analytically valid methodology (one that takes valuation levels into account) and you will see that it is entirely possible that it will take 22 years or even longer for stock investors to break even this time. Honey, We Forgot the People and Thereby Got the Number Wrong!
The true worst-case scenario is a lot worse than it has been portrayed to be by Jeremy Siegel in his book Stocks for the Long Run.
Jeremy Siegel is dangerous because he understates the value proposition offered by safe asset classes.
The statement above in which Siegel notes that there is at least one case on the record in which a safe investment class did not provide a superior return misleads the casual reader into thinking that it is not possible for investors of today to lock in a more promising deal from safe investments. There was a time not too long ago when Treasury Inflation-Protected Securities (TIPS) were paying a guaranteed annual return of over 4 percent real. That beats going with stocks and possibly waiting 22 years or longer to break even by a whopping margin.
The 4 percent TIPS were not available at the time Siegel wrote his book. So he certainly cannot be blamed for not making his readers aware of that particular investment opportunity. However, it is fair to blame him for the manner in which he set up the comparison between stocks and safe investment classes.
Safe investment classes have a wonderful characteristic not shared by stocks. With stocks, you must be willing to hold for the long term or you face the possibility of taking on huge losses because of the short-term volatility of this asset class. The same is not at all so with the safe investment classes. If you are not able to find a good return on a safe investment class, you can always take a not-good-return for a short time-period and then switch out to a better deal when one comes along. Siegel’s comparison assumes the same “lock-in” for both stocks and non-stock investment classes, but most asset classes do not require an investor lock-in to the extent that stocks do.
Jeremy Siegel is dangerous because he fails to reveal the warning signs of when stocks offer a poor long-term value proposition.
Given Siegel’s belief that stocks are always a good long-term buy, it is hardly surprising that he fails to tell us what to look for to determine when they are not. Still, this is a huge omission. Middle-class investors have a pressing practical need to know when they need to lower their stock allocations a bit because of the increased risk associated with buying overpriced stocks.
If you want to know about what Jeremy Siegel failed to tell you, please take a look at the Stock-Return Predictor (see the tab to the left of this page). By entering various valuation levels into the calculator, you can determine when the long-term return offered by stocks is amazing, when it is just strong, and when it is not so hot (the default results show that today it is not so hot).
If you want to review objective research of the type performed by Jeremy Siegel but in an analytically valid way (that is, incorporating the effects of valuations into the analysis), please take a look at John Walter Russell’s Early-Retirement-Planning-Insights.com site. Mind-blowing stuff!
Jeremy Siegel is dangerous because he overstates the risks of stock ownership while also understating it.
It’s not just that Jeremy Siegel paints stocks with too rosy a glow. The other side of the story is that, by ignoring the effects of valuations, he at other times paints stocks with too dark an overcast.
Siegel improprerly suggests that stocks are almost sure to provide a positive return to those willing to hold their shares for 17 years. I can do even better than that without needing to engage in any fudging of the numbers. Using the Stock-Return Predictor, I can report that, if you purchase stocks at moderate prices (when the P/E10 level is 14), you can be virtually certain of a positive return in 10 years!
Stocks are an amazing asset class. Long-term stock prices are highly (but not precisely) predictable. Jeremy Siegel is responsible for those two powerful investing insights.
Stocks are not always the best asset class for the long run. When prices get too high, you want to lower your allocation to stocks to avoid the huge hit you are likely to take if you fail to do so and to position yourself to buy when prices return to reasonable levels. Jeremy Siegel got just enough right to be persuasive and just enough wrong to be dangerous.
Read Jeremy Siegel. Study John Walter Russell. Siegel’s book is the rough first draft. Russell’s web site is the classic work that will pay us rewards for return visits for decades to come. Now we know what really works for the long run and it’s not to put your money in stocks and forget about it.