The European debt crisis and America’s own debt troubles are keeping many investors away from stocks. But author and Wharton Professor Jeremy Siegel says the odds are in favor of the market making some impressive gains in the coming years.
“Many stock bulls are calling for a 10% to 15% gain this year,” Siegel tells Barron’s. “But I would not be surprised to see the market up 20% or more, even if earnings growth slows.”
Siegel’s research draws on more than a century of stock market returns, and shows a clear trend, Barron’s Gene Epstein says: that after periods of poor performance, the market tends to snap back and push much higher, and vice versa — the so-called “rubber band effect”.
Based on Siegel’s research, Epstein says, “Two-thirds of the time, after a five-year period like the one we’ve just seen, the market rises fast enough to lift the Dow to 15,000 or higher from present levels over the following two years. The same pattern applies to Dow 17,000 or higher, except that happens just half the time.”
Part of Siegel’s bullishness on 2012 is due to the fact that, while earnings growth was strong last year, stocks struggled amid fears of a U.S. economic slowdown and the European debt crisis. “From this point, the market will be sensitive to an easing in both concerns, which Siegel expects will be forthcoming,” writes Epstein. “Economic data so far released have lent credence to a pickup in GDP growth, and future data should lend further support. As for euro land, while the region as a whole is probably in recession already, the market should gain support from continuing signs that a major meltdown is unlikely.”
Epstein notes that the Dow 15,000 and Dow 17,000 targets aren’t really as impressive as they may seem. Assuming just 6% earnings growth in Dow companies over the next two years — well below the 9% consensus estimates — price/earnings ratios would need to expand only slightly, from the current low level of 13.1 to about 13.6. And to get to 17,000 with that 6% earnings growth, the market P/E would need only to climb to 15.4 — a fairly average level.
Siegel’s colleague, Jeremy Schwartz, also discusses how share buybacks have picked up the slack from dividend decreases that have occurred over the past couple decades. And Schwartz offers some interesting data on how the “rubber band effect” has worked over the past century-plus, and to what degree it could impact the market in the coming two years.