Telling attendees that U.S. large-cap stocks remain undervalued by about 25%, Jeremy Siegel revealed a statistical aberration in the cyclically adjusted P/E ratio favored by such prominent market bears as Jeremy Grantham and Yale University's Robert Shiller.

Speaking at TD Ameritrade Institutional's conference today, Siegel expressed sympathy with the desire of market watchers to smooth out the vagaries of the business in devising an appropriate measure to value equities. Using 10-year averages of prices and earnings normally would facilitate this.

Except when you factor in a year like 2008, when three companies-Citigroup, AIG and Bank of America-lost a combined $450 billion. Together with other financial companies writing off subprime, the component companies of the S&P 500 saw their profits decline by an "unheard-of" 80%, distorting the statistics, Siegel noted. By the end of 2008, the market capitalization of these three struggling giants amounted to 1% of the S&P 500.

Siegel checked the national income accounts to find out what their measure of the decline in corporate profits was in 2008. It was a dramatic 25% fall, which still was far from a negative 80%.

Some argue that today's near-record level of corporate profits are unsustainable, but Siegel questioned their logic. How can corporate profits be unsustainable only "two and a half years into a recovery?" he asked.

With the S&P 500 selling at 12.5 times earnings, Siegel estimated that the index should rise to 1586 if inflation stays normal. If we move to a low inflation era, the index could move much higher to about 2010.


-Evan Simonoff