Siegel: Stocks Still a Good Long-Term Bet

This was previously published by Knowledge@Wharton. It is being republished as a bonus for TheStreet.com readers.

The government's rescue of Fannie Mae (FNM), Freddie Mac (FRE) and AIG (AIG) demonstrated clearly that the financial turmoil continues on Wall Street. In an interview with Knowledge@Wharton, Wharton finance professor Jeremy Siegel says there are some positive signals in stocks and corporate earnings, but it's too soon to say the market has hit bottom. Siegel also talked about inflation and commodities. An edited transcript of the conversation follows.

Knowledge@Wharton: The financial crisis continues on Wall Street and stocks are in turmoil. We asked Wharton finance professor Jeremy Siegel about the key factors driving today's market and what's ahead. Welcome, Professor Siegel.

Siegel: I'm happy to be here.

Knowledge@Wharton: Well, the markets are just crazy. A few days ago, they were down 500 points, the biggest drop since 2001. And, yesterday, they were up 140 points; though the Fed decided not to cut interest rates. Why is it that the Stock Market can't decide which way to go?

Siegel: Yesterday, it was much more important that AIG get solved than whether the Fed cuts 50 basis points. And, that is basically why it did actually fall during the day at about 100 points, when they didn't lower it. But, then when there were rumors of the deal coming through on AIG, it rallied at about 200, 250. It was much more important to salvage the liquidity of the financial system.

But, the news is fast and furious. Which is the next one to go? What do these balance sheets look like? I mean with so much news coming in, it's not surprising that we are getting all of this volatility.

Knowledge@Wharton: When you look at the markets, there's an endless blizzard of statistics. I mean when you look at the employment numbers, the inflation numbers and on and on and on. What figures or data should we really be focusing on?

Siegel: There is the economic data and then there is the financial data. The economic data indicates a mild recession. And in fact, some might not really think it is a recession -- certainly a slow down, but we have had much more severe ones than this. The financial data has been unprecedented because of what we have had -- with some of the biggest investment banks in the world having taken leveraged positions with assets that they believed were safe and sound and they were not.

We never had a real estate bubble to the extent that we have had over the last two or three years -- and never did the financial industry go as heavily into that bubble as they did. And, that combination combined with excessive leverage has proved toxic.

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Knowledge@Wharton: Is it your sense that we are closer to the end of this drama or are we still somewhere in the beginning, or is it that we just can't tell?

Siegel: People are asking "Which inning are we in?" and others are saying "Just a minute, we're in a double header." It just keeps on going. I honestly had thought that last July we had seen the worst of it and probably even with Bear Stearns. The question is: How many of these financial institutions have these bad assets on their balance sheets? Now, again, the bad assets so far are still confined, by and large, to real estate.

What happened with Lehman Brothers (LEH) was that not only did they have bad mortgage-backed securities, they actually had real estate. They were trying to flip real estate. They bought some of it at the peak and they thought that they could get rid of it. So, in some cases, it was not just the mortgage-backed securities; it was a very leveraged position in an overblown real estate market. And, until you really know to what extent other financial institutions have gotten involved in this, it's hard to know which firms are going to be in trouble next.

Let me say however, the firms that have kept their head and did not get involved in this, they are going to do very well -- and are doing very well.

Knowledge@Wharton: This would be Goldman Sachs (GS), for example.