Answer to Ritholtz Question

Barry Ritholtz asks here:  “I want to crowd-source the arguments pro and con for [Stocks for the Long Run] SFTLR — What does Siegel get right, what does he get wrong? What is the weakest and strongest parts of his viewpoints?”

My view:

Jeremy Siegel’s detractors include Charlie Munger:

“Q: Ibbotson finds 10% average returns back to 1926, and Jeremy Siegel has found roughly the same back to 1802.

Munger:  Jeremy Siegel’s numbers are total balderdash. When you go back that long ago, you’ve got a different bunch of companies. You’ve got a bunch of railroads. It’s a different world. I think it’s like extrapolating human development by looking at the evolution of life from the worm on up. He’s a nut case. There wasn’t enough common stock investment for the ordinary person in 1880 to put in your eye.” Source

The fact that Sigel’s numbers include survivorship bias makes Munger even more right.

Having said that, people like David Swensen have shown with statistics that are more reliable than Siegel’s numbers that there is enough of an equity premium that investors should have an “equity bias for portfolios with a long term time horizon”.

One should only have a “bias” toward equity and not an obsession with equity for the same reason asset allocation is so important:  there is risk that the greater volatility of stocks can produce significant problems one of which is liquidity and the other is the risk that you bought at what appeared to be the bottom which in fact was the top.

(“I believe in stocks for the long run – but only if purchased at the right price.” Bill Gross, December 2008″).

Siegel claims: “it is little known that in the long run, the risks in stocks are less than those found in bonds and even bills!”

The problem with Siegel’s advice is that people retire in the short run and colleges need cash in the short run, etc.  As Keynes famously said, markets can remain irrational longer than you can remain solvent. Return to the mean does not solve some short term liquidity/return problems.

Jack Bogle weighs in:

“I think there’s some merit in Bill’s position that stocks are going to give returns that are much lower than historical levels and bonds definitely will give much lower returns. I happen to think he’s a little bit low. For example he says in a balanced portfolio nominal returns might be bonds and stocks half and half roughly and the return on that portfolio might be 3 percent before deducting inflation and my own work suggests 5 percent. That’s not any room for debate there.

You know it’s not that one of us is right and one of us is wrong we’re both looking for much lower than historical returns and I think that’s a virtual certainty.

Now whether that means the cult of equities is dead I can’t help but be reminded of the Businessweek cover “the death of equity” right at the best time to buy equities in history. This is not such a time by the way be clear, there’s a lot to worry about today. Bill puts his finger accurately and importantly on one big worry. And that is if the real return is going to be, lets use my 5 percent, how are these pension funds going to get that 8 percent, they’re assuming. And the answer is they’re not going to get it. We’re talk about a bubble the pension funds are dreaming of a bubble that isn’t going to recover. That’s a national problem it’s state and local governments, its corporations and there’s no defense of that 8 percent and Bill is right there.”

Bogle went on to say that yields on today’s government bonds have a 91 – 92 percent correlation with the returns you’re going to get over the next 10 years.

He said Siegel’s buy and hold investment principle is never dead and added, “I don’t look for a great decade ahead but I look for a decent one.”  

Regarding “Buy & Hold delivers inferior returns” I think the threshold question to ask is whether  the investor is what Buffet calls a “know nothing investor” (i.e., a muppet) or a “know something investor.”  For muppets, “buy and hold” plus wise asset allocation  is the best strategy, as Bogle argues.  Yes it takes discipline but so does not trading an ETF and actually saving (see the previous post below re this and investing generally for muppets).  Like Churchill’s statement about capitalism, it has many problems but “buy and hold” in the form of an index plus wise allocation for a muppet beats any alternative.

For an active investor (not a muppet) who “knows something” buy and hold can work  if you have a long term horizon and buy high quality stocks at cheap prices*.  If you don’t do what Buffett does and have the skill, emotional disposition and discipline to do so you better have some other source of Alpha.  Active mutual fund returns indicate that few people have that source of alpha.

Regarding “buy and hold”,  I have serious problems with this study re Buffett.

It seems to me an attempt to assume away anything that would prevent the authors from using formulas containing Greek letters.

“… accounting for the general tendency of high-quality, safe, and cheap stocks to outperform can explain much of Buffett’s performance and controlling for these factors makes Buffett’s alpha statistically insignificant.”

What the authors do is control for factors Buffett uses to generate alpha and then conclude that his alpha “is statistically insignificant.”   

How is picking stocks that are “safe, high quality and cheap” before the fact and having the discipline not to chase retruns not alpha? As an example, Kodak and Xerox appeared “safe.”  Some people thought Nortel, HP and RIM were “safe.” Lots of banks seemed “safe.” Fannie Mae, Freddie Mac, Qwest and Goodyear seemed “safe” to some people.   Determining what stocks are “safe” after the fact is easy.

P.s.,  More from Munger regarding Siegel’s predictions:

Charlie Munger was asked about Jeremy Siegel’s book Stocks for the Long Run.

Munger:  “I think Jeremy Siegel is demented.”

Buffett:  “Well he’s a very nice guy.”

Charlie Munger :   “He may well be a very nice guy, but he’s comparing apples to elephants in trying to make accurate projections about the future.”  2006 Berkshire Meeting

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