Investors presently appear to be taking past investment returns and economic growth at face value, without considering their underlying drivers at all. My impression is that while the U.S. may very well encounter credit strains or other economic dislocations in the coming years, nothing is actually required for yet another equity market collapse except the gradual recognition by investors of a reality that already exists. Strip away the effects of short-term cyclical factors that have now been largely exhausted, and it becomes clear that the financial markets have again become a Potemkin Village.


Investors now rely on unemployment to remain depressed, profit margins to remain at record levels, and valuations to be sustained at historic elevations, simply for U.S. real GDP to average 1-2% annually in the coming years, and for stocks to achieve low single-digit total returns. More likely, any normalization at all in these cyclical factors is likely to produce near-zero growth in U.S. GDP and corporate earnings in the coming years, with steep market losses over the completion of the current cycle, gradually recovering to an overall total return of zero for the S&P 500 over the coming 12-year horizon.

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