Tuesday, May 08, 2007

Siegel Bullish

Although the Standard & Poor’s 500 Index is still just below its all time high reached in March 2000, many high-profile market analysts, including Jeremy Grantham of GMO and Cliff Asness from AQR Capital, are pessimistic. They claim that profits are at a cyclical peak and that a low dividend yield will generate poor future returns for stocks.

Yet I believe the opposite is true and think that the current valuation of the stock market is very favorable for investors. Before explaining why, let me respond to these bears.

The quote above is from Jeremy Siegel, the finance professor from Wharton. He goes on to explain that he's bullish on stocks for two reasons. First, the current earnings yield (the inverse of the price/earnings ratio) is quite a bit above current bond yields and are therefore attractive to long term investors. Second, he makes an arguement for an expansion in P/E multiples, which is less convincing in my mind. I am more pessimistic about interest rates and therefore more pessimistic about P/E expansion.

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