Friday, November 6, 2015



The inherent problem of "eternal bullishness" is the "wilfull blindness" to the underlying data in an effort to chase short-term returns.

What is grossly important in achieving long-term investment success is not necessarily being "right" during the first half of the cycle, but not being "wrong" during the second half.

If you are expecting an economic recovery, and a continuation of the bull market, then the economic data must begin to improve markedly in the months ahead. The problem has been that each bounce in the economic data has failed within the context of a declining trend. This is not a good thing and is why we continue to witness an erosion in the growth rates of corporate earnings and profitability. Eventually, that erosion combined, with excessive valuations, will weigh on the financial markets which is potentially much of what we are witnessing now.

The economy continues to ebb and flow between weak growth and no growth. This puts the Federal Reserve at risk of a policy mistake that could trip the economy into an outright recession. While there have certainly been positive bumps in the data, as pent-up demand is released back into the economy, the inability to sustain growth is most concerning.

Ultimately, stocks are not magical pieces of paper that provide double-digit returns over the long run. In fact, we've just had a 15-year period of lousy (less than 5% annualized) returns, and it all has to do with valuation.

While WallStreet, and the financial media, continue to push individuals into the casino to increase revenues, what is ultimately forgotten is that stocks are ownership units of businesses. While that seems banal, future equity returns are simply a function of the value you pay today for a share of future profits.

The chart below shows that rolling 20-year returns from current valuation levels have been substantially less optimistic. After fees, taxes and inflation, it is substantially worse.

There is an increasing possibility that "risk" may well outweigh "reward" for some time going forward.

A century of market history provides strong reason to believe that any recent gains will be wiped out in spades. 

Those who bought stocks last week in response to hints of more easing from Draghi – and the rate cut in China – may find themselves in the same position as Pavlov's dogs, wondering why no meal follows the ringing of the bell.

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