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John Hussman: The Price of Distortion

June 17, 2013
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"Today, an economic forecast is more like the analysis of a criminal mind than the evaluation of economic data."

Tyler Durden (pen name) at ZeroHedge

The central issue in the current financial markets, in my estimation, is distortion. Because monetary distortion dominates the financial markets here (helped by fiscal distortions that have temporarily elevated profit margins about 70% above their historical norms), the only certainty is that short-term market fluctuations will be dominated by the vagaries of the near-criminal mind that dictates how far those distortions will be pushed. Investors cannot control that decision. Still, I don’t have a single doubt that over the full course of the present market cycle, investors will be better served by adhering to informed discipline than by tying their destiny to predictions about what the Fed will or will not do next.

To fully understand that confidence in discipline, one needs to fully understand the market cycle. Since 1940, the market has experienced 13 bull market advances of at least 25% from a bear market low, and 13 bear market declines of at least 20% from a bull market high. Bull market advances during this period have averaged a 123% price gain, a 162% total return, and a duration of 4.4 years. Bear market declines during this period have averaged a 35% price loss, a 32% loss including dividends, and a duration of 1.3 years. So dividends have helped to boost the bull market gains and mute the bear market losses to some extent, but with a dividend yield of just over 2% on the S&P 500, this effect is not very strong at present. Combining bull and bear markets, the average market cycle has averaged a 45% price gain, a 79% total return, and a duration of 5.6 years. This works out to an annualized total return of 10.9%, and an annualized capital gain of 6.9%, that gap being bridged by dividends, which have represented nearly 40% of total returns over time.

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The chart below should make it fairly evident that an elevated share of profits to GDP is tightly related to weak subsequent profit growth (the right scale is inverted), and one does not need to make particularly “long run” assertions about this process. I continue to expect corporate profits to contract significantly over the next few years.



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