In this past weekend’s newsletter, I discussed the potential for an end to the current bull market cycle. It was not surprising that even before the *“digital ink was dry,”* I received emails and comments questioning the premise.

It is certainly not surprising that after one of the longest cyclical bull markets in history that individuals are ebullient about the long-term prospects of investing. The ongoing interventions by global Central Banks have led to T.T.I.D. *(This Time Is Different)* and T.I.N.A. *(There Is No Alternative)* which has become a pervasive, and *“Pavlovian,”* investor mindset. But therein lies the real story.

**The chart below shows every economic expansion going back to 1871 and the subsequent market decline.**

This chart should make one point very clear – **this cycle will end.**

However, for now, there is little doubt **the bullish bias exists as individuals continue to hold historically high levels of equity and leverage, chasing yield in the riskiest of areas, and maintaining relatively low levels of cash** as shown in the charts below.

There are only a few people, besides me, that discuss the probabilities of lower returns over the next decade. But let’s do some basic math.

First, the general consensus is that stocks will return:

*6%-8%/year in real (inflation-adjusted) terms,*

*plus or minus whatever changes we see in valuation ratios.*

Plug in the math and we get the following scenarios:

*If P/E10 declines from 30X to 19X over the next decade, equity returns should be roughly 3%/year real or 5%/year nominal.*

*If P/E10 declines to 15X returns fall to 1%/year real or 3%/year nominal.*

*If P/E10 remains at current levels, returns should be 6%/year real or 8%/year nominal.*

Here is the problem with the math.

First, this assumes that stocks will compound at some rate, every year, going forward. This is a common mistake that is made in return analysis. Equities do not compound at a stagnant rate of growth but rather experience a rather high degree of volatility over time.

**The ‘ power of compounding’ ONLY WORKS when you do not lose money.** As shown, after three straight years of 10% returns,

**a drawdown of just 10% cuts the average annual compound growth rate by 50%**. Furthermore, it then requires a 30% return to regain the average rate of return required.

**In reality, chasing returns is much less important to your long-term investment success than most believe.**

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