Strong corporate earnings and global economic growth will propel the stock market higher as the Dow flirts with the all-time record it reached in January 2000 and the S&P 500 breaches a five-year high, according to noted Wharton finance professor Jeremy Siegel.
But gold is not a good bet for the long term, said Siegel, known for calling the bull market top in March 2000 and author of the classic "Stocks for the Long Run" and "The Future for Investors."
"I'm concerned about commodities. I do think they are in a bubble," Siegel said in an office crammed with books, awards and photos of himself with former Fed Chairman Alan Greenspan and billionaire investor Warren Buffett.
Siegel has long been a proponent of holding stocks for the long-term over other securities. But he took heat from investors after proclaiming that Internet stocks were overvalued — soon before the bear market began six years ago.
The current stock market, he said, is healthier and has fewer speculators, but don't hanker for a return of the roaring bull market of the 1980s and 1990s. Siegel thinks it was an unprecedented event that likely won't come back for a long time.
Question: These are heady times for the stock market. Do you think that momentum can be sustained?
Siegel: I think so. There are two things that are very positive for stock prices. One is the tremendous earnings growth that we have seen. The number of firms reporting above expectations is very high.
Secondly, we have a world increase in economic activity. For the first time in more than 20 years, we have Europe, Japan and the U.S., as well as the developing countries, contributing to economic growth. This is the world economy firing on all engines for the first time in a long time and I think that will also serve to raise stock prices.
Question: How does this market compare to the last bull market we had? Are investors acting differently or making some of the same mistakes again?
Siegel: I think this is a much healthier market. The bull market that we had in the late 1990s was fueled by speculation in technology stocks and Internet stocks. Technology stocks were sent to unheard of levels of over 100 times earnings and that could not be sustained.
Today, I see much less speculation.
Question: Will we ever see the roaring bull market that characterized the 1980s and 1990s ever again?
Siegel: That was unprecedented in the 200-year history of the U.S. stock market. We returned 15 to 18 percent per year on average for nearly 20 years. We've never had that before ... My feeling is that the memory and the pain of that bubble breaking will be long-lasting on investors and keep them from getting as over-enthusiastic about the market, at least for quite a number of years.
Question: After years of phenomenal growth, the housing market is showing signs of slowing down. What's your take on the direction of real estate?
Siegel: I don't predict a crash. I don't think it was a tremendous bubble like technology stocks. There were some areas in the country that probably did get over-speculated, but overall, the price rise was justified by the interest rate drop.
But because we have interest rate increases, both on the long-end and the short-end, my feeling is that we are probably entering a rather long period where real estate prices will be fairly flat.
The history of real estate prices is we've got long flat periods, a rise for a decade or so and then another flat period. I think we're into a flat period and by the way, at the beginning of these flat periods, you often get downward adjustment of prices in the most speculative markets.
Question: Gold prices recently reached $700 an ounce, a quarter-century high. Is that the place to be right now?
Siegel: I'd say no. I'm concerned about commodities. I do think they are in a bubble.
I think we have a lot of money chasing commodity funds because their returns have been so spectacular in the last 12 months.
But precious metals have not proved to be good long-term investments for investors. Leave them to the short-run speculators and right now, I think that market is dangerous.
Question: How can an investor profit from the run-up in oil prices? How do you play that sector?
Siegel: The best way really is to own energy shares. In my book, "The Future for Investors," I talked about the long-run attraction of the energy sector. Now, since I've written that book, energy has gone up tremendously so I don't want anyone to overweight in that sector.
But I'd rather hold the stocks that own the resources rather than the outright commodity (in the form of exchange-traded funds). I think in the long run you'll get a better return.
Question: What's your outlook on the dollar?
Siegel: The dollar has taken a bit of a hit here and I think that that's partly related to really short-term factors.
But in the long run, I'm not bearish on the dollar in contrast to those who worry about the very large and growing current account and trade deficits.
I see ... an offsetting strength of the dollar in the desire of the booming, developing countries to hold dollar-denominated assets and I don't think that's (been factored) in.
Question: What do you think the Fed should do to best manage the U.S. economy, given inflation fears from higher energy prices?
Siegel: We have raised interest rates dramatically. ... My feeling is that that has already turned the housing market and it will turn the commodity market. Once those two sectors are stabilized, long-term inflation is under control.
The Fed has to be very careful about over-tightening, going too far. They must realize, as I think they do, that we had a 400 basis-point increase in rates over the last two years and it might be wise to pause and assess the situation.
I am acutely aware that if commodities continue to rise and the economy continues to boom at an unsustainable rate that the Fed must continue to raise interest rates and I believe they will.
We have done a lot so far. We may have to do more, but my feeling is that this would be a good time to pause and assess the situation.
Question: What's your take on the new Fed chairman, Ben Bernanke?
Siegel: I'm very positive about him. I know him. He's a very bright man and I think an excellent choice to succeed Alan Greenspan. He's learning his position — there were some recent leaks (to CNBC anchor Maria Bartiromo) that should not have happened — but he is a very quick study and he will learn from those mistakes, which aren't overly serious.
I think he will guide the U.S. economy very well in the coming decades.
(MSBC is a joint venture of Microsoft and NBC.)
Question: You've said that investors often make the mistake of buying into the fastest growing stocks because they tend to be overpriced. You also said that the best performing investments are found in shrinking industries and in slower-growing countries. That seems counterintuitive.
Siegel: People confuse growth with return.
I found, in my historical studies, that growth stocks, particularly small growth stocks, are in fact often overbet by the market and overpriced. Even though a number of them go on to grow, the vast majority don't live up to the expectations of investors. Sometimes slow-growing companies, particularly those that are profitable, that return cash to shareholders and give dividends, have proved to be the best performing stocks in the long run.
The same thing holds with countries. The fastest-growing country over the last 20 years is China and yet it has had the worst dollar returns for investors — again, overpriced securities.
You must look at the price relative to earnings and the dividend yield.
Question: You are optimistic about the financial future of the aging population in developed countries. Others have taken a pessimistic viewpoint, saying that the needs of aging Baby Boomers in the U.S. will strain Social Security and other programs. How can you be so upbeat?
Siegel: Eighty-five percent of the world's population outside the developed world is not rapidly aging ... If the developing world can continue to grow as they have over the last five to 10 years — particularly China and now India — these countries will be able to produce and supply many of the goods that will be needed by the Baby Boomers that will be entering into retirement.
These countries will also help support our asset prices, being major buyers of the major corporations in the world.
Question: Do you see an era of declining influence and power of the Western countries? Is that cause for concern?
Siegel: I see a drop in the share of the economy that Western powers will occupy in the coming years. My own projection is that ... China's economy could be as big as the U.S., Canada, Western Europe and Japan put together by the year 2050.
All the developed world will become smaller as part of the world economy.
Question: Given your projection of the importance of globalization, how should one allocate assets?
Siegel: I've recommended that up to 40 percent of your equity assets should be in stocks that are headquartered outside the U.S. ... We have to recognize that over half of the world's capital today is outside the U.S., and that will be growing dramatically in the coming years.