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Excerpt from fund manager John Hussman's weekly essay on the U.S. market:

The following chart... projects the potential growth rate of earnings by amortizing the difference between current earnings and the well-defined historical trendline that connects S&P 500 earnings from peak-to-peak across market cycles. This approach has been quite reliable over 7-year horizons (except for those 7-year periods that ended in the late 1990's market bubble). At present, the likely 7-year total return on the S&P 500 is in the low single digits.

7yr return projections 16 07 2007

As I've frequently noted, it's not useful to attempt to forecast specific short-term market outcomes, but valuations have an enormous and reliable impact on long-term outcomes. Investors ignore evidence like this at their peril.

It is also useful to emphasize that the defensive case does not require any expectation that earnings will fall short in the months ahead, or even that profit margins will contract over the coming quarters. If you look at the historical data, it is clear that the correlation between year-over-year earnings growth and year-over-year market performance is zero anyway. The argument is that even on the basis of current earnings -– record profit margins and all –- the market is very richly priced. On the basis of normalized profit margins, the situation is even worse. But we do not need to argue that earnings will decline or disappoint. The potential for margins to erode certainly strengthens the case, but is not the basis of our defensiveness...

Investment professionals that hold themselves out on CNBC as "long-term investors" should be troubled by the paltry long-term returns currently priced into stocks, as well as the historical tendency toward abrupt short- and intermediate-term losses given current conditions. Otherwise any talk of being a “long-term investor” is nothing but lip service.

No, multiples are not as bad as they were in the late 1990's, but those valuations have also been followed by market returns below Treasury bill yields for eight years, and even those meager returns have been achieved only because the market has returned to high valuations currently. If the late 1990's now represent our standard of appropriate valuation, we may as well bury our savings in a bottle in the back yard, because the outcomes will be similar. When even modest future investment returns rely on profit margins and valuation multiples remaining at elevated levels indefinitely, there is no margin for error, and one is no longer investing.