The investment industry mantra of 'stocks for the long run' has never looked a more empty slogan. How long is that exactly? Given recent hikes in the Equity Risk Premium, bonds have now outperformed on a reinvestment basis since 1968, so a 21 year old beginning his career 41 years ago and seeking a passive buy and hold pension strategy would have been well served by ignoring stocks completely as shown in the chart below (survivor bias in equity indices being a bigger issue than for bonds makes the underlying performance even worse). Since 1900 the Equity Risk Premium has averaged about 4% a year; the current rate is about 5.3% (a rough and ready calculation is to add the dividend yield of 3% to expected long-term nominal dividend growth of 5% and then subtract the ten-year bond yield of 2.7%).

Over the past 50 years, the earnings yield has averaged around five percentage points higher than the return on cash. The gap is now around eight points and has only ever briefly been in double digits. On these and other indicators, equities are now around fair-value on a long-term basis, having commenced a secular bear market in 2000 at historic levels of overvaluation. That implies medium-term returns of 8-10% compound. Of course, secular bear markets almost invariably undershoot fair-value considerations; in 1974 and 1982 markets bottomed at a 14% earnings yield. The real question for equity investors is: what will be the sustainable level of corporate profit margins and revenue growth in a US economy undergoing a multi-year deleveraging process? A lot depends on whether you think benign economic conditions in the last 15 years (not only massive credit expansion but disinflation and the baby boomer peak spending years) and the high returns on equity they generated were a historic anomaly or can somehow be resuscitated by current reflationary policy.