This Rally Is Nowhere Near Over

The stock market's rally over the past three months has many investors thinking it must be too good to be true -- and definitely too big to last. One well-known stock expert, though, says that we may just be getting started.

Many know Wharton Business School finance professor Jeremy Siegel for his research of the stock market. He's made many significant contributions to our understanding of stocks, from the importance of dividends for total returns on stocks to the historical long-term outperformance of stocks over bonds.

But recently, Siegel has drawn attention for his thoughts on the immediate future for stocks. In recent weeks, both as a speaker at a financial conference and in an interview on NPR, he has spoken positively about the current state of the markets. While others worry about how quickly the rally could reverse itself, Siegel thinks stocks have plenty of room to run.

Reversion to the mean
In simplest terms, the basic bull argument goes like this. Over the long haul, stocks have consistently delivered attractive returns. Moreover, every time stocks have suffered through a major bear market, ensuing returns going forward have looked attractive. Even during the Great Depression after the Crash of 1929, when stocks lost half their value by December 1930, the stock market gave investors a real return of 7% annually over the next five years.

Put another way, if you plot a trendline of long-term stock-market returns from the early 1800s to the present, you'll find that when the market fell significantly below that trend line, it typically responded with subsequent strong performance, averaging more than 20% annually in both the following one- and three-year periods.

By those standards, the rally since March has only barely gotten us above where we were at the beginning of 2009 -- which was already well below the historical trendline. In that light, stocks could continue pushing upward for some time.

Good dividends
Siegel also points to positive developments in stock dividends. While financial stocks have notoriously cut payouts, many others, especially outside the financial sector, have continued raising dividends. Here's a recent sample:

Source: Yahoo! Finance.

Especially after big drops, dividend stocks have played a big role in recoveries. Dividends helped stock investors salvage something from the Great Depression -- research from Siegel found that while it took 25 years for the Dow to match its 1929 level, shareholders who reinvested dividends realized an average annual gain of 6% over that time period. Similarly, the strength of non-financial dividends right now gives Siegel confidence that returns going forward should bump up nicely.

Counterpoint
Of course, when you go outside the U.S., it's easy to find markets that have yet to return to long-term positive performance. The most obvious is Japan, whose stock market still languishes nearly 75% below its all-time high in 1989. You could even make the same counterargument with the U.S. stocks that make up the Nasdaq composite, which also hasn't come close to approaching its highs in 2000.

Clinging to historical returns as absolute proof of a bright future is clearly foolhardy. Yet the bear argument closely resembles the "this time it's different" sentiment that has served followers so badly over time. While there's always the chance that it actually is different this time, the record of mistaken calls in the past supports taking a skeptical view of those who advocate the end of stocks.

Rallying stocks have already gone a long way toward restoring investor confidence. If Siegel's predictions prove right, then everyone may be able to breathe an even bigger sigh of relief in the not-so-distant future.

For more on investing in stocks, read about:

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