Thursday, February 26, 2009

Jeremy James Siegel

Jeremy Siegel is right and the Roubini minions are missing the point

Jeremy Siegel wrote an op-ed on the WSJ saying the current earnings methodology is incorrect. He is right in some scenarios yet all the Roubini minions who feel they need to be bearish to be right are attacking him. They would be right in normal circustances but Siegel is correct when you are talking about massive negative earnings, negative networth and stocks close to $0(low weighting in the index)

Lets say all the financials go down to $0.01c a share and they continue to lose billions matter of fact they lose so much, the SP500 earnings are negative according to the current SP methology
the PE of the SP500 is infinite, their earnings never recover and they keep losing forever
If you buy the SP500, you are essentially getting financials
for free, yes they lose money but so what, you get all the other sectors who are making money and paying dividends for your income. You donot lose on the aggregate because common stocks under deeply negative networth, bankruptcy dont create a liability for you

Another example, lets say all stocks go to $0.01c a share except for XOM, they are all losing huge amounts but for some reason XOM keeps printing money, if you buy the SPY you are getting the sp499 for free and an nicely profitable XOM who will make you money and pay dividends. Yet according to the Siegel critics its a bad buy because the index has negative earnings and an infinite PE forever, yet what are you doing is
essentially buying XOM and getting free options on the rest, since common stocks dont create liabilities even if they have negative networth or go bust

So the total earnings of the SP500 donot matter in those scenarios, what matters is
what you get when you buy it and what price you paid for it. Thats because common stocks offers unlimited upside with limited downside

Bespoke wrote this
"Imagine you have two investments. The first is worth $1,000, and over the last year it generated $100 in ncome. The second investment is only worth $100, but over the last year, it had a loss of $100. Most people would probably think of their investments in the way S&P calculates the earnings for the S&P 500. You would have total investments of $1,100 ($1,000+$100) and earnings of zero ($100 profit on $1,000 investment plus $100 loss on $100 investment). "

Their mistake is not carrying that logic further, lets say the $100 investment(Inv1) on the second year loses $50,000(not a typo), and the $1000 investment(Inv2) earns $200. The Inv1
is a writeoff to you by then(its market value will be close to $0 as well), you probably dont expect anything from that ever again, you will mark down that investment to $0, so what that Inv1 earns is 100% irrelevant because common stocks dont create a liability to you. You will 100% care about Inv2 as it will became your index with 100% mental weighting, yet according to the current methodology as a long that 'dog' is in the index, it will produce massive negative earnings for that index and an infinite PE ratio

Bottom line is that financials are distorting the PE ratio of the SP500 and Siegel is right that stocks are cheaper than they appear(Even though I'm not long yet)


  1. siegel is definitely NOT right, but that doesn't mean that there isn't a different point we can take from this, which is the one you discuss. as a commenter on another forum explained, "the creditors eat those losses, not the shareholders"

  2. agreed, Siegel is definitely wrong. All of these other more nuanced points about whether or not the P/E in these extreme cases is good indicator of over all market value are valid arguments. Unfortunately, if you read the op-ed this is not the argument that Siegel lays out. Instead he challenges S&P's calculation of P/E to ultimately imply that stocks are cheap. Bottom line is that S&P calculates the P/E for the index correctly.

  3. Kid and anon,
    I think Siegel could be 100% right even in non 'lower bound' situations. I think I will post about in the next few days

  4. maybe you should roll out a "100% mental index" ETF.