Jeremy Siegel’s Magnum Opus
On March 14, 2019, Jeremy Siegel, a Wharton Business School Professor and nationally known author of Stocks for the Long Run, sponsored a conference in Huntsman Hall on the campus of the University of Pennsylvania. The purpose was to memorialize his colleague and friend, Dr. Marshall Blume, a co-founder of Prudent Management Associates, who had died unexpectedly on January 27. Professor Siegel spoke first during the memorial, which was attended by every employee of PMA, and, among his other comments, he noted that the first edition of Stocks for the Long Run, published in 1994, drew heavily on data he and Marshall had developed together. Professor Siegel stated that not only did he and Marshall perform this research together, but also that when Professor Siegel told Marshall about his desire to incorporate this research into his new book, Marshall gave him carte blanche permission to do so without seeking credit.
Indeed, the acknowledgment to the First Edition of Stocks for the Long Run begins with this sentence: “The idea for this book originated in 1989 when the New York Stock Exchange approached my Wharton colleague, Marshall Blume, and me to produce a work on the history of the Exchange, from both an economic and institutional perspective.” Notably, in 2022, Professor Siegel further honored Professor Blume by making an inaugural gift of one million dollars to establish the Marshall Blume Professor of Finance endowed professorship — a “gift of this size from a faculty member is rare” reported the Wharton Magazine.
In the second sentence of the acknowledgment to the first edition of Stocks for the Long Run, Professor Siegel set forth his core thesis: “I began [in 1990] to gather data on the long-term returns on various securities, suspecting, and indeed confirming, that stocks outperformed all other financial assets over US history.”
After the success of the initial publication of his book in 1994, Siegel would repeat and expand on this thesis in four subsequent editions, published in 1998, 2002, 2007 and 2014. Now in late 2022 he has published his Sixth – and he intimates in his Preface, his final – edition of this work.
A brief comparison of the First Edition to the Sixth Edition gives a sense of what this book has become: (1) the first edition had no end notes while the sixth edition has hundreds of detailed endnotes across 34 pages; (2) the first edition had 19 chapters, the sixth has 28 across seven subparts; and (3) the first edition was just over 300 pages whereas the sixth is 424. In short, the book is now a magnum opus, covering not only the history of asset class returns, but also such topics as the monetary and financial history of the United States, global investing, modern portfolio theory, factor investing, ESG investing, behavioral finance, and much more. In short, no topic of importance to contemporary finance seems to go undiscussed.
Nevertheless, the key thesis about stocks remains the same. The essential empirical evidence for this thesis is historical data that compares the returns of US equities to other asset classes. Siegel describes this data as the “most important” in the book: it establishes the outperformance during the period 1802-2021 of the real (after inflation) total returns of stocks (6.9%) compared to long-term government bonds (3.6%), US Treasury bills (2.5%), gold (.6%) and the US dollar (-1.4%). In dollar terms, these returns mean that one dollar invested in US stocks in 1802 would yield in after-inflation dollars over 2.3 million in 2021, whereas long-term government bonds would have yielded just over two-thousand dollars.
Moreover, the real returns of equities showed “extraordinary stability” over different periods during these almost 220 years: “6.7% per year from 1802 through 1870, 6.6 percent from 1871 through 1925, and 7.1 percent per year from 1926 through 2021, a return which is brought down to 6.76% if we include the bear market in the first half of 2022.” The performance of equities during the last period is particularly significant because “virtually all the inflation that the United States has experienced” in its history has occurred post-WWII, yet this inflation “has not at all diminished the real return on equities.”
Siegel concludes, based on this and other evidence set forth in his book, that stocks are the best investment for the long run in terms of achievable returns, but Siegel does not conclude that this means that an all stock portfolio is what all investors should select all of the time. First of all, the returns set forth above are “total” returns, which means that they assume all dividends, income and any other cash flow from the asset are reinvested back into the portfolio always. Siegel rightly recognizes that “it is rare for anyone to accumulate wealth for long periods of time without consuming [spending] part of his or her return.” Any investment portfolio, therefore, must be built with an investor’s spending needs in mind. An allocation between stocks and bonds should also take into account an investor’s age and “naturally risk preferences are important.”
The consistent historical outperformance of stocks is now acknowledged by academic finance and investment professionals and is prominent enough that it has achieved its own name – the “equity risk premium.” Siegel’s book is an important work using historical evidence to document the persistence of the equity risk premium over the past two centuries.
Given the perspective of this book, therefore, it is surprising that Siegel does not discuss whether there is a theoretical basis for the equity risk premium, as opposed to proving its empirical persistence over a long period of history. Without some theoretical understanding of the basis for and persistence of the equity risk premium, there will always be a nagging concern that – as virtually every financial institution in America seems to state in every disclosure – “past performance is no guarantee of future results.” Indeed, in the Forward to the 2nd edition of Stocks for the Long Run, Peter Bernstein, another giant in the world of financial literature (he founded the Journal of Portfolio Management among other accomplishments) noted that “relationships sanctified by history have been blown apart” and that “the past, no matter how instructive, is always the past.”
There is little reason to doubt that Siegel firmly believes that there is a theoretical basis for the equity risk premium. Indeed, he is one of a number of prominent professionals to participate in a recent “Equity Risk Premium Forum” sponsored by the CFA Institute (the forum was chaired by Laurence B. Siegel – the Director of Research at CFA Institute Research Foundation – who will be one of the speakers at the PMA luncheon being held in person on October 25, 2023). A main discussion point of this Forum was not whether the equity risk premium would continue, but whether it would underperform its historical averages.
One reason Siegel may not discuss the question of whether there must be an equity risk premium is that he finds reasonable an explanation provided by Peter Bernstein in the Foreword to the Fourth edition. Indeed, Bernstein’s Fourth edition Foreword is quoted extensively in the Foreword to the Sixth Edition. Bernstein’s answer is that the risk premium “must remain intact if the system is going to survive.” This is because “bonds cannot and should not outperform equities over the long run” as equities “promise their owners nothing” and thus are riskier assets than bonds which are contracts enforceable in law. Under these circumstances stocks “must” provide a larger return for those seeking long term gains “or our system will come to an end, and with a bang, not a whimper.”
Bernstein ended his Preface there and did not define precisely what he meant by “our system,” but I will be presumptuous enough to venture a guess – “our system” refers to the free enterprise system in which people are free to make their own decisions about how to arrange their affairs, work, invest, spend and live. Should that system ever end, with either a bang or a whimper, whether and to what extent the equity risk premium persists, will be the least of our worries. Those who invest in marketable securities, stocks or bonds, are, ultimately, betting on the continuation of “our system.”