It’s a great time to buy stocks, says noted financial historian

One of this country’s preeminent financial economists and historians believes the stock market is a great buy today. In fact, when compared to similar periods over the last 200 years of stock market history, all of the unsettling events of recent years have contributed to the market’s positive prospects, says Jeremy J. Siegel of the Wharton School and author of “Stocks for the Long Run.” “It’s exactly times like this, when bearish sentiment has brought down valuations, that your chance of strong returns in the following years is greatest,” he recently told The New York Times.

Siegel probably knows more about stock market history than anyone. His reconstructions of U.S. market returns going back to 1802 lead him to believe that markets have entered, or will soon enter, a prolonged upswing. The reason, he says, is simple: stock market returns have fluctuated around an average real return (meaning after inflation) of 6 percent annually. After periods when returns have exceeded that average, they come down to earth and overshoot to the low side. Then they go up again, reverting to the mean long-term return.

During the 1980s and 1990s, Siegel told another interviewer recently, stocks offered an unprecedented run of double-digit returns. Those decades boosted stock market valuations to 60 percent above their long term trends. Over the last decade, two bear markets have pushed stocks as much as 30 percent below their trend lines.”Basically what we have done over the last 10 years is gone from a very overvalued market to an undervalued market,” he says. Although it is possible the market could get even more undervalued for a period, eventually returns will rebound and could even overshoot their long term trends again.

Over the long term the average price to earnings ratio of the stock market is about 15 (price to earnings measures how much investors are paying for each $1 in corporate earnings). But today, the projected price earnings ratio for this year is 13, and for next year 11. That leaves the market at bargain prices. Even better, the average market price to earnings ratio is about 17 in periods of low inflation, just as we have now. That enhances today’s bargain.

Siegel thinks a double-dip recession is unlikely. Economic growth will slow, but a recession implies at least one quarter of negative growth, and not even the most pessimistic economic forecasts come near that, he says. Siegel also scoffs at doom and gloom forecasts like that of technical forecaster Robert Prechter, who sees an astounding market collapse coming. Instead, the prospects for positive stock market returns over the next 10 and 20 years are very likely if post-World War II patterns continue, he says. Average real returns could be as high as 11 percent per year.

Finally, Siegel notes that valuations matter to investors. “If you are buying at or below long-term valuations, there’s no reason why you won’t get the long term returns which have been so outstanding in stocks,” he says.