Executive Summary

• Why stocks may average 0% return (at best!) for the next decade
• The depressing data in
  • Retail sales
  • Housing
  • Manufacturing
  • Consumer confidence
• Why the time to short the market, or implement risk management strategies, is looking near

If you have not yet read The Stock Market's Shaky Foundation, available free to all readers, please click here to read it first.

To be sure, there is one piece of fundamental information that has supported equity prices since late 2009; and that’s corporate earnings.

Those have vaulted to new highs, despite the weak economic recovery, on the back of ultra-cheap borrowing (which reduces interest costs which are deducted from earnings), government deficit spending, and low household savings:

While the parabolic rise in corporate earnings is quite impressive, they are also historically unprecedented and certainly unsustainable. 

When we look at the same chart seen above but on a percent change yr/yr basis we see that they have been slowing down remarkably and aren't that far above the zero mark:

But the real trouble with corporate earnings comes from the fact that, when they are expressed as a percent of GDP, they are at levels that have never been seen before. They will almost certainly ‘mean revert’ from nearly 11% of GDP to the more typical 6% (while probably overshooting first).

Here’s how John Hussman puts it:

[I]nvestors are taking current earnings at face value, as if they are representative of long-term flows, at a time when current earnings are more unrepresentative of those flows than at any time in history.

The problem is not simply that earnings are likely to retreat deeply over the next few years. Rather, the problem is that investors have embedded the assumption of permanently elevated profit margins into stock prices, leaving the market about 80-100% above levels that would provide investors with historically adequate long-term returns.

An equivalent way to say this is that stocks are currently at levels that we estimate will provide roughly zero nominal total returns over the next 7-10 years, with historically adequate long-term returns thereafter.