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Excerpt from the Hussman Funds' Weekly Market Comment (11/1/10):

Over the past decade, stock market investors have experienced enormous volatility, including two separate market declines in excess of 50%. Despite periodic advances, at the end of it all, as a reward for their patience, investors have achieved an average annual total return of approximately zero. If the past decade has been a lesson for investors, that lesson should have two components. The first is that valuations matter. Though valuations often have little impact on short-term returns over periods of less than a few years, they are undoubtedly the single best predictor of long-term market returns. Moreover, high valuations are ultimately followed by far deeper periodic losses than emerge from low valuations. Put simply, greater risk does not imply greater reward if the risks that investors take are overvalued and inefficient ones.

The second lesson is that the effects of wasteful misallocation of capital cannot be fixed by policies that encourage the wasteful misallocation of capital. Fortunately or unfortunately, policies can often help to prop up unsustainable patterns of activity in order to "kick the can down the road." This can postpone major economic adjustments, but often makes the ultimate adjustment even worse.

Put simply, policies and investment practices that are effective and friendly to the short-term can often be destructive and violent to the long-term, particularly when those policies and practices encourage the misallocation of capital. Presently, investors are resting their financial security on hopes about quantitative easing - a policy that is essentially intended to skew the allocation of capital and provoke risk-taking in an environment where risk premiums are already thin.

...

I remain unconvinced even now that we should view the current economic climate as a standard post-war economic cycle. Still, the experience of the past few years has clearly added to our post-war dataset in that it now contains a full-blown credit-crisis. Every new data point adds information, either in creating new distinctions, or increasing confidence in the distinctions one has already learned. The past three years have confirmed much of what we already knew about valuation, while the enormous volatility of prices, despite an overall market loss, has contributed significantly to our analysis of market action.

In any event, whether or not one believes the current economic cycle should be viewed as a "typical post-war recovery," it is clear that our valuation methods have been accurate measures of likely market returns over time - even during the recent crisis. At present, the long-term outlook for equities is unfavorable on the basis of valuation, so regardless of shorter-tem influences, I expect that long-term investors are likely to be ill-served by investing in stocks at current levels.

Source: John Hussman: Based on Valuation, Expect Poor Long-Term Stock Market Performance