Still More Q&As

Knowledge@Wharton: And I can hear a lot of listeners out there gnashing their teeth and saying -- well, look, I live in the real world here and I'm worried about my retirement. Are you telling me that if my asset allocation model used up to this point said I'm a 30-year-old and I should have 70% in stocks, that I should have 40% in stocks? What decisions should people make?

Stambaugh: Sorry, I can't help you there.

Knowledge@Wharton: Jeremy, what do you think?

Siegel: It is easy to jump to the conclusion "Oh my goodness, stocks are riskier. Let me get into these other asset classes." Global warming really happens. These are big trend-changing events that really could affect all assets.

Knowledge@Wharton: And just to go back for a second, Rob did say that these uncertainties could be uncertainties on the good side. Good things can happen as well.

Stambaugh: Yes, except that uncertainty is never viewed as a good thing for an investor. In general, we think of -- as Jeremy said earlier -- investors being risk averse. So as you crank up uncertainty, you need to provide some reward. The fact that you can be surprised on the good side, generally, to a risk averse investor, doesn't offset totally the fact that you could be surprised on the downside.

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Siegel: In my book, The Future for Investors, I speculate a bit about trends of technology and the fact that the communications revolution suddenly opening up -- connecting people and research centers in a way that hasn't been done before -- could ... increase growth. There are potentials for very favorable surprises in terms of inventions, discoveries, innovation, etc. ... so, in a way, Rob is right. You don't generally like uncertainty because the downside is more hurtful than the upside is helpful. But there can very well be that upside, too.

Knowledge@Wharton: But an investor would not be irrational to sit there and say, "Well I realize there are uncertainties of global warming and these other kinds of things we've mentioned, but at the same time maybe somebody will invent a breakthrough battery for electric cars, or nuclear fusion will suddenly become practical," or something like that.

Siegel: It's not too late for that. Some people say there's already too much carbon dioxide in the atmosphere, but I understand what you're saying.

Knowledge@Wharton: I just want to turn finally for a minute or two to the market of the past couple of years, which has been just terrible for people. The S&P 500 is still down about 45% from its peak. Are these events that we have seen in the last couple of years anomalies or are they things that people should expect to happen every once in a while? Where do they fit into your view of the trends over the years?

Siegel: We had a 20-year period of very low volatility of real economic variables. We had two very mild recessions. If you look at quarterly changes in real GDP or any of the real economic factors, their variability went down. That lulled a lot of people into thinking, "Hey, we're in a more stable world." That led to a lot more leverage and, therefore, a ripple -- which I interpreted as not being something disastrous -- turned into a tidal wave because of the leverage firms took. It pushed us back into a recession which I now look at as about as severe as I remember in the 1970s and 1980s.... Obviously there are people out there talking about the 1930s. We are miles away from that at the present time. But it looks like we have moved back at least on this recession to the severity of the '70s and '80s. And that period of low volatility -- which economists called "the great moderation" -- seems to be over and could have been an anomaly.

Knowledge@Wharton: And your view?

Stambaugh: I guess I should take the opportunity at this point, since you raised the issue of the current economic environment, to point out that I would not want to claim as we sit here currently that stock volatility in the long run is going to be higher than current short-run volatility. We were at very historic highs in terms of short-run volatility. The VIX, Volatility Index, has hit all-time highs recently. So certainly we expect that sort of short-run volatility to moderate. I wouldn't want readers and listeners to misinterpret our work as claiming that we're making a statement about the current environment where we think long-run volatility is going to be even higher than it is today. Our paper is more about what a more typical environment -- or more average environment -- for volatility would offer an investor in terms of short-run versus long-run. That is, in a more typical environment we would argue that stocks look riskier in the long run, but certainly today stock's volatilities are at all-time highs -- at least over relatively short horizons such as those measured by things like the VIX.

Knowledge@Wharton: So you would not expect this kind of volatility to continue for long periods?

Stambaugh: I would certainly hope not. I don't expect it -- I don't think anyone does -- and we'd all be very surprised if it were to continue.

Knowledge@Wharton: That gets us to the last question. It is customary to ask Professor Siegel for his thoughts about what the markets and the economy are likely to do over the next year or two.

Stambaugh: I will defer to Jeremy on that question.

Siegel: I put my head on the chopping block each time I'm here. I was giving a talk this morning and I said, "I can finally take off my bullet-proof vest."I talk about stocks and there are a few people who say, "Maybe that is better." What the rally reflects is that people are now saying, "You know what? The world isn't coming to an end." Obviously I'm saying that people were really discounting [the market] because we had a financial shock almost as bad as the 1930s, but certainly not an economic shock with the same tremendous response. So, again, it's going to be a recession just like we had in the '70s and '80s, and those periods have always been very good buying opportunities for stock investors. So you missed a part of this rally, but it is still a very reasonably priced market and you will be very amply rewarded in the long run.

Knowledge@Wharton: So you still believe in stocks for the long run?

Siegel: Oh, yes, I definitely do. Let me just say that ...  once you're down 50% from the high -- and we're actually down a little bit more but we've come back -- the returns from those levels are even greater than the long-run mean. We can't be certain of that, but you face historically even better prospects.

Knowledge@Wharton: Thank you. And Professor Stambaugh, thank you very much for your paper as well. It reminds us that we can't always count on the past being prologue.