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

. The Verdict of History. January 1802

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

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

    2. The Verdict of History

    3. Total Real Return Indices

    4. Annual Stock Market Returns

    5. Annual Bond Market Returns

    6. Long and Short-term Risk of Stocks and Bonds

    7. Holding Period Risk for Annual Real Returns

    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) = 1258. 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%

    9. Bond Returns and Equity Premium Ten year at 4.47%, 30-year at 4.68% If we subtract 2.5% for inflation, we get a real yield of 1.97% and 2.18%. TIPs yields are 2.11% and 2.07%. Equity Premium is about 4% now. Expect real yields to rise about 1% Long-Term Equity Premium = 3%.

    10. Rationale for Lower Equity Returns Greater Liquidity and ease of diversification in the equity Market Greater understanding by investors of the equity premium. Increasingly favorable taxation of equity.

    11. The Future for Investors

    12.

    13. Is Updating Essential to indexed Returns? Richard Foster and Sarah Kaplan from McKinsey & Co, in their 2001 book, Creative Destruction state (p. 28): “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.”

    14. Change in Sector Weights 1957-2005

    15. S&P 500 Portfolios

    16. Performance of Portfolios (1957-2003)

    17. Twenty Top Performing Survivors

    18. Top Twenty on November 30

    19. Growth Does Not Guarantee Return

    20. Is there a “Corporate El Dorado”? Quotation from Foster and Kaplan’s Creative Destruction: p. 9 “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.” Top Performing Stock From 1925-2004 Philip Morris, Return 17.36% vs. 10.04% Market. Top Performing Stock From 1950 Philip Morris, Return 17.87% vs. 11.47% Market. Top Performing Stock from original S&P 500 in 1957 Philip Morris; Return 19.72% vs. 10.86% for S&P 500. $1,000 put in S&P 500 when it was founded would turn into $138,549 by the end of 2004. $1,000 put in Philip Morris at the same time would grow to over $5.5 million.

    21. Dividend Yield and Relative Performance

    22. The Aging of the Population The Most Critical Long-term Economic Issue Facing the Developed World

    23. Long Term Demographic Trends

    24. Age Wave -- US

    25. Age Wave – Japan

    26. Big Questions The Biggest Questions Facing the Developed World Who Will Produce the Goods? Who Will Buy the Assets?

    27. Retirement Age must rise to 73

    28. Productivity Growth and Retirement Can faster productivity growth help the Aging Problem? Let us be extraordinarily optimistic and assume future productivity growth averages 3 ˝ % per year, 70% above long term average of 2.2%.

    29. 3.5% Productivity reduces retirement age 2-3 years

    30. Immigration? 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.

    31. But there is Hope Outside the developed countries, the population of the world is much younger. Let’s look at India.

    32. Age Wave -- India

    33. Trade Deficits and Aging Throughout history, the “old” have sold assets to the young in exchange for goods. Today in US, Florida’s retirees sell assets to and import goods from other 49 states. In the future the US will sell its assets to the rest of the world. Success depends on rapid growth in the developing world.

    38. Retirement Age with high growth in LDCs

    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.

    41. Growth and Stock Return in Emerging Markets

    42. Projected Trade Surpluses and Deficits

    43. Conclusions I believe that growth in developing world will offset slowing in aging economies and support future equity prices. Do not jump into emerging markets without examining valuation. Forward looking real returns on US stocks 5˝% to 6˝%, about one percent below long term historical average. These returns are far above what can be expected in bonds or even real estate.

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