Posted by Joseph Y. Calhoun, III

John Hussman’s latest commentary:

Over the past 12 years or so, I’ve been repeatedly astonished at the tendency of investors to do things that they should have known to avoid simply with the use of a calculator and basic arithmetic. We’ve used numerous metrics during this period to show that the estimation of long-term market returns (7-10 years and beyond) doesn’t require calculus or statistics, but fairly direct methods to normalize earnings, plus a bit of arithmetic. Rich valuations are predictably followed by sub-par returns. As a result, investors have earned an average annual total return of just 2.4% in the S&P 500 over the past 12 years, while enduring two separate instances where they have lost about half of their money as part of the ride. Essentially, we have gone nowhere in an interesting way. At present, investors have priced the market at a level that makes a continuation of this experience likely for several years to come.

I noted last week that at current valuations, the S&P 500 is priced to deliver a total return of only about 5.7% annually over the coming decade. Though it generally takes about 7-10 years to reliably revert from valuation extremes, a good portion of that reversion often occurs within 5 years (outside of the twin bubbles to the 2000 and 2007 highs). Presently, a normalization of valuations, not to extreme undervaluation but simply a reversion to post-war, non-bubble norms, would imply an average annual return for the S&P 500 of just 2.97% over the coming 5 year period.

If Hussman is right - and I suspect he is - we’ve just had a cyclical bull market within the context of a secular bear market. When another bear phase starts and from what level is the big question. As I said in this week’s commentary, we haven’t addressed the underlying issues that produced the recession. If we haven’t solved the problems it seems likely the correction will resume at some point. Hussman as usual is well worth reading the whole thing.