Perma-bull and Wharton professor Jeremy Siegel is predicting that the Dow Jones Industrial Average could reach 15,000 by the end of 2013 and 17,000 shortly thereafter. Regular folk and students enrolled in second and third tier business schools should be heartened by the fact that Wharton employs Mr. Siegal. After all, if Wharton sees fit to continue to employ a chronic failure, how “premier” can the school really be? For example, Mr. Siegal predicted that the mortgage mess would right itself, the economy would come out of recession, the S&P would gain 8%-10%, financial stocks would boom, and the Federal Reserve would raise rates in 2008. The poorest performing group of stocks over the past few years, internationals and foreign sticks, he predicted would have banner returns. He even predicted–or hoped–that Rudy Giuliani would win the Republican nomination. The S&P 500 lost 38.49 percent in 2008, its worst year since 1937. Financials underperformed all market sectors, losing 56.95 percent. The Federal Reserve lowered rates further, and well, you all know how Rudy “Florida or Bust” Giuliani fared in the 2008 election. The bottom line is that there is a good living to be made in concocting eloquent charts, graphs, and reasons for an increase in stock values. The public does not tune in to be put to sleep by facts and figure and astute and honest analysis. Siegal is no different that the perpetual stock-picking flop Jim Cramer. Siegal however carries the cache of respect that inures to professors at Ivy League institutions, making him far more dangerous than the Cramer sideshow. He was among the voices calling for the massive Bush tax cuts, deregulation, and the end of the estate tax.
As I have written before, historical gains in the stock market have been inextricably tied to the United States rigorous system of regulation. It is this very regulation that has been unwound, shot, tied up, disemboweled, and sent to the wood-pile that has for generations attracted investors from around the globe to United States equities. Our equities were perceived as being extraordinarily safe investments, and as such investors were willing to pay a far higher premium to own them. The result of a fierce regulatory regime had been nearly a century of fairly consistent and predictable returns near 10% annually. Those days are long gone. With the dismantling of Glass-Steagall, leverage requirements, derivative regulation, and recent wild west IPO deregulation in the form of the JOBS Act, so too has worldwide confidence in our markets deteriorated. The consequence of these actions will be slow or stagnant growth of United States equities and more and more frequent periods of boom and bust brought about by one get rich quick scheme after another.
Evidence of investor flight is quietly emerging. Investments in so-called frontier markets are on the rise. With the perception of safety all but vanished from the United States and other western powers such as the U.K., large investors are seeking more reward for what many of them believe to be similar levels of overall risk. In other words, if the upside potential in U.S. equities is limited but the downside risk is significant, why not invest in regions and countries with equal upside and downside risk? It make a lot of sense.
It isn’t to say that investors have dumped trillions of dollars of U.S. equity investments and Treasury Bond holdings and abandoned us altogether. It is to say that the U.S. is on a path in that direction. As such, any predictions of where the stock market will be two years from now, or twenty years from now are meaningless. The carpet-bombing of financial regulation has, to my mind at least, even put the stalwart Case-Shiller CAPE under intense scrutiny. CAPE measures PE ratios of the S&P 500 companies in ten year averages rather than in one years or shorter time periods, giving a more accurate indication of where current prices are relative to long term averages. CAPE also serves to smooth out periods of extreme exuberance and put the bullish television and radio talking heads in perspective. With regulation dismantled, the measurement going forward is inherently misleading, and will continue to be so until many years pass under the new regulatory environment.
This situation has been caused equally by Democratic and Republican administrations. Admittedly, the predominant share of deregulatory legislation and administrative changes have taken place at the behest of Republican lawmakers or under Republican Administrations. However, Democratic Presidents have signed off on rather than fought the legislation, and most recently President Obama’s economic policies have reinforced the spurious notion that regulation hinders growth and job creation. Moreover, the voice of the people has not been sufficiently loud since the housing collapse to force lawmakers to enact new tougher regulations. We the people bear equal blame with the two parties. The repercussions are frightening. We are left with the onerous and ultimately ineffective Dodd-Frank Act, and a host of other half-measures and changes within the federal regulatory agencies that are not only inadequate but under-funded. It is time to avert your eyes and ears from the professors and pundits who attempt to sell you on the idea that the U.S. stock market will continue to perform as it has in the past. At least until we return to the regulatory regime of the past.