Future for Investors Prof. Jeremy J. Siegel ~ The Wharton School Boston Security Analysts Society ~ December 5, 2005

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 2 The Verdict of History

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 3 January 1802 – June 30, 2005 Total Real Return Indices

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 4 Annual Stock Market Returns Real Returns Long- Term % Major Sub- Periods I % II % III % Post-War Periods % % % % % Updated through June 30, 2005

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 5 Annual Bond Market Returns Real Returns Long- Term % Major Sub- Periods I % II % III % Post-War Periods % % % % % Updated through June 30, 2005

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 6 Long and Short-term Risk of Stocks and Bonds

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 7 Holding Period Risk for Annual Real Returns 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Holding Period Risk 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Actual Stocks Actual Bonds Actual Bills Historical Data and Random Walk (Dashed Line) 1802 – 2004

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 8 Projected Equity Returns  Earnings Yield, or 1/P-E ratio, is excellent long-term predictor of real stock returns.  Average P-E ratio in last 130 years = 15; average earnings yield 6.7%.  S&P 500 Estimate of next 12 months operating earnings $85.55 (end 4Q06)  S&P 500 (Nov. 30) = P-E ratio 14.70, earning yield = 6.80%.  If you take reported earnings, estimate $77.90, for a P-E ratio of 16.15, EY of 6.19%  If you take core earnings estimate $72.57, P-E ratio 17.33, earnings yield 5.77%

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 9 Bond Returns and Equity Premium n Ten year at 4.47%, 30-year at 4.68% n If we subtract 2.5% for inflation, we get a real yield of 1.97% and 2.18%. n TIPs yields are 2.11% and 2.07%. n Equity Premium is about 4% now. n Expect real yields to rise about 1% n Long-Term Equity Premium = 3%.

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 10 Rationale for Lower Equity Returns n Greater Liquidity and ease of diversification in the equity Market n Greater understanding by investors of the equity premium. n Increasingly favorable taxation of equity.

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 11 The Future for Investors

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 12 What Happened to the Original S&P 500 Formulated in 1957?

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 13 Is Updating Essential to indexed Returns? n Richard Foster and Sarah Kaplan from McKinsey & Co, in their 2001 book, Creative Destruction state (p. 28): n “New companies generate higher levels of total return to shareholders than do the older survivors. …. For example if the S&P 500 were today made up of only those companies that were on the list when it was formed in 1957, the overall performance would have been significantly less.”

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 14 Change in Sector Weights

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 15 S&P 500 Portfolios Original S&P 500 Firms 500 Survivors’ Portfolio Merged Firms 92 + Reissued From Privatization 11 = Direct Descendants Portfolio Spin-offs 111 = Total Descendants Portfolio 339

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 16 Value 11.31%15.72% Equal 12.28%18.45% Survivors Portfolio Value 11.35%15.93% Equal 12.18%18.55% Direct Descendants Performance of Portfolios ( ) Where did Foster and Kaplan go wrong? Confused Return and Market Value Portfolio Initial Weighting Return Risk Sharpe Ratio S&P 500Value 10.85%17.02% Value 11.40%16.08% Equal 12.15%18.53% Total Descendants New Stocks in S&P 500 often overpriced: Indexing and bubbles

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 17 Twenty Top Performing Survivors

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 18 Top Twenty on November 30

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 19 Growth Does Not Guarantee Return * Info Tech EX-IBM (16.2%,10.6%)

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 20 Is there a “Corporate El Dorado”? Quotation from Foster and Kaplan’s Creative Destruction : p. 9 n “McKinsey’s long-term studies of corporate birth, survival, and death in America clearly show that the corporate equivalent of El Dorado, the golden company that continually performs better than the markets, has never existed (emphasis theirs). It is a myth.” n Top Performing Stock From –Philip Morris, Return 17.36% vs % Market. n Top Performing Stock From 1950 –Philip Morris, Return 17.87% vs % Market. n Top Performing Stock from original S&P 500 in 1957 –Philip Morris; Return 19.72% vs % for S&P 500. n $1,000 put in S&P 500 when it was founded would turn into $138,549 by the end of n $1,000 put in Philip Morris at the same time would grow to over $5.5 million.

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 21 Dividend Yield and Relative Performance

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 22 The Aging of the Population The Most Critical Long-term Economic Issue Facing the Developed World The Next Fifty Years

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 23 Long Term Demographic Trends Past marked by (1) rising life expectancy and (2) falling Retirement Age But this trend Cannot Continue 1.6 Years 14.4 Years

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 24 Age Wave -- US

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 25 Age Wave – Japan

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 26 Big Questions The Biggest Questions Facing the Developed World Who Will Produce the Goods? Who Will Buy the Assets?

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 27 Retirement Age must rise to Years 9.2 Years

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 28 Productivity Growth and Retirement n C an faster productivity growth help the Aging Problem? n Let us be extraordinarily optimistic and assume future productivity growth averages 3 ½ % per year, 70% above long term average of 2.2%.

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel % Productivity reduces retirement age 2-3 years

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 30 Immigration? n The number of immigrants to the US over the next 45 years needed to keep the retirement age in the mid 60s would be about one-half billion, far in excess of the current population.

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 31 But there is Hope n Outside the developed countries, the population of the world is much younger. n Let’s look at India.

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 32 Age Wave -- India

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 33 Trade Deficits and Aging n Throughout history, the “old” have sold assets to the young in exchange for goods. n Today in US, Florida’s retirees sell assets to and import goods from other 49 states. n In the future the US will sell its assets to the rest of the world. n Success depends on rapid growth in the developing world.

World GDP 2000Population % 15.2% 44.6% 56.4%

23.1% 76.9% Population 2050World GDP % 88.2%

Per Capita Income Relative to US 2000 Per Capita Income Relative to US 2050

Per Capita Income Relative to US 1960 Per Capita Income Relative to US 2003

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 38 Retirement Age with high growth in LDCs

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 39 The Global Solution The answer to our question: Who will produce our goods? Who will buy our assets? Is the same: The Developing Countries By the middle of this century Developing Countries will own most of world’s capital. Developed Economies will run increasing trade Deficits Trade Deficits will be demographically determined

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 40 Stock Market Capitalization %92.3% 33.0% 67.0% Stock Market Capitalization 2050

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 41 Growth and Stock Return in Emerging Markets China

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 42 Projected Trade Surpluses and Deficits

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 43 Conclusions n I believe that growth in developing world will offset slowing in aging economies and support future equity prices. n Do not jump into emerging markets without examining valuation. n Forward looking real returns on US stocks 5½% to 6½%, about one percent below long term historical average. n These returns are far above what can be expected in bonds or even real estate.

Copyright Jeremy J. Siegel Stocks for the Long Run and Future For Investors by Jeremy J. Siegel 44 Visit JeremySiegel.com