Fed should be forward looking
One of the reasons behind this year’s stock market slump is inflation. Consumer prices were rising at their fastest pace in 40 years. While the headline CPI number has cooled off a bit recently — August’s inflation rate was 8.3% year-over-year — it’s still worryingly high.
To tame inflation, the Fed is raising interest rates aggressively. The central bank increased its benchmark interest rates by 75 basis points last month, marking the third such hike in a row.
If rampant inflation continues, more rate hikes could be on the way. And that does not bode well for stocks.
Siegel points to one segment of inflation that is cooling down: housing. But that isn’t properly reflected in the index numbers.
“We pointed out that the way these indices are constructed, that housing costs are very lagged, and they're going to continue to go up, even though as we saw the Case-Shiller Housing Index, and the National Housing Index, housing prices are going down,” he says.
Siegel suggests that instead of making decisions based on lagging indicators, the Fed “has to be forward looking.”
“They have to look at what's going on in the market, in the housing market, in the rental market, in the commodity market.”
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Diversify now‘Excellent value’
The pullback in stocks has been painful, but that’s exactly why this could be an opportunity.
The reason, Siegel explains, is that the fall in stocks has brought their valuations down.
“When you're talking about 16 times earnings, and even if they're clipped by a recession, and you shouldn't just base it on recession earnings, you should base it on longer term earnings, which I think are very favorable … I think these are just absolutely excellent values,” he says.
Of course, having attractive valuations does not mean stocks won’t drop further.
“Could it go down more? Of course, in the short run. In bear markets, it’s gone down more,” Siegel admits, adding that “anything can happen on the short term.”
No lost decade
The outlook can be bleak, even for those who already made billions from the markets.
Billionaire investor Stanley Druckenmiller recently said that stock market returns could be flat for the next decade.
Ray Dalio’s Bridgewater Associates warned earlier this year that we could be facing a “lost decade” for stock market investors.
Siegel remains optimistic.
“I disagree with that completely that the Dow or S&P 500 would be flat [over the next decade],” he says.
“We added 40% to the money supply since the pandemic began in March of 2020. Earnings have historically moved up just with inflation and the money supply. So stocks should be 40% higher than they were.”
The economist explains that at one point, stocks were 50% to 55% higher than pre-pandemic levels. But with the recent pullback, they are just 20% higher. And that means investors have something to look forward to for the next decade.
“To say that 10 years from now, we're going to have the same Dow when the earnings yields that I see there on the market, show that your returns are going to be probably in the neighborhood of 6% per year after inflation.”
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