Ironically, investors have been slow to recognize the implications of declining structural growth precisely because of the opium-like qualities of the Federal Reserve policies that are responsible for it.

We presently estimate both razor-thin (and even negative) equity risk premiums from a valuation standpoint, and also a uniform, if subtle, shift toward increasing risk-aversion among investors.

By equating the delay of consequences with the absence of consequences, investors have now set up the most extreme episode of equity market speculation in U.S. history next to the 1929 and 2000 market peaks.

So here’s a question: “Is there clear evidence, across history, showing that large, activist changes in monetary policy instruments are reliably correlated to positive outcomes, of a meaningful size, in the real economy?” The essential truth is this. Most of the variation in output, employment growth, and inflation across history can be reasonably predicted using lagged values of non-monetary variables alone. Adding information from monetary variables like the Federal Funds rate, the monetary base, and even Treasury yields, provides very little additional information. Moreover, only the “systematic” component of monetary policy - the part that can be explained by lagged non-monetary variables, has any meaningful correlation at all with subsequent economic outcomes. The remaining “activist” component does very little except to cause distortions, particularly in the financial markets. Those distortions ultimately cause economic damage when they collapse, but over a much longer horizon than the Fed seems to consider.

The most favorable market return/risk profiles we identify are associated with a material retreat in valuations that is then joined by an early improvement in market action. I have no question that these conditions will emerge over the completion of the current market cycle.

Put simply, most apparent “opportunities” to obtain investment returns above zero in conventional assets over the coming decade are based on a misunderstanding of valuations, total returns, and historical yield relationships. At current valuations, virtually everything is priced for a decade of zero.

My friend and teacher Thich Nhat Hanh once said, “It is not impermanence that makes us suffer. What makes us suffer is wanting things to be permanent when they are not. Wilting flowers do not cause suffering; it is the unrealistic desire that flowers not wilt that causes suffering.”

There’s a field in one of our data sets that rarely sees much play, being driven primarily by only the most extreme combination of overvaluation, overbullish sentiment, and overbought conditions we’ve identified across history. It’s one of a variety of such syndromes we track, and I’ve simply labeled it “Bubble,” because with a single exception, this extreme variant has only emerged just before the worst market collapses in the past century.

From a long-term and full-cycle perspective, the most reliable valuation measures we follow - those with the strongest correlation with actual subsequent stock market returns across history - are consistent with roughly zero S&P 500 nominal total returns on a 10-12 year horizon, and the likelihood of an interim market loss of about 40-55% over the completion of the current cycle.

The global economic outlook has experienced a downward shock in recent weeks, largely as a result of the “Brexit” referendum where British citizens voted to exit the European Union, coupled with deterioration in China that has led it to accelerate the depreciation of its currency. That combined deterioration, coupled with expectations of further central bank easing, has resulted in a plunge in global interest rates, with $20 trillion of government debt (primarily in Japan and Europe) now sporting negative yields. The plunge in yields has also affected U.S. Treasury securities, where the 10-year Treasury bond yield dropped as low as 1.32% last week. This advance in asset prices isn’t a reflection of economic health. To the contrary, it is a yield-seeking race to the bottom resulting from a downward shock to the global economy.

“Understand that securities are not net economic wealth. They are a claim of one party in the economy - by virtue of past saving - on the future output produced by others. Fundamentally, it's the act of value-added production that ‘injects’ purchasing power into the economy (as well as the objects available to be purchased), because by that action the economy has goods and services that did not exist previously with the same value. True wealth is embodied in the capacity to produce (productive capital, stored resources, infrastructure, knowledge), and net income is created when that capacity is expressed in productive activity that adds value that didn't exist before.

First things first. While the full attention of financial market participants is focused on “Brexit” - last week’s British referendum to exit the European Union - the singular factor to recognize here is that the vulnerability of the financial markets to steep losses has very little to do with Brexit per se. Rather, years of yield-seeking speculation, encouraged by central banks, had already brought the financial markets to a precipice prior to last week’s vote.

Imagine the collapse of an extended speculative tech bubble, resulting in a broad economic recession. Imagine if the Federal Reserve had persistently slashed short-term interest rates during the downturn, to no avail, leaving rates at just 1% by the time the S&P 500 had lost half of its value and the Nasdaq 100 collapsed by 83%. Imagine that the Fed kept rates suppressed, in the initially well-meaning hope of encouraging lending, growth and employment. Imagine that the depressed level of interest rates made investors feel starved for yield, and drove them to look for safe alternatives to Treasury bills.

Last week, the 10-year Treasury yield dropped to just 1.6%. Technician Walter Murphy noted that his index of global 10-year yields also plunged to an all-time low. The overall structure of global bond yields is undoubtedly the outcome of years of aggressive monetary easing, though the break to fresh lows among European bank stocks may convey some additional information content. Of course, the compression of prospective investment returns isn’t limited to bonds. On the basis of the valuation measures best correlated with actual subsequent S&P 500 total returns across history, prospective 10-12 year S&P 500 nominal total returns have declined to just 0-2% by our estimates, with negative real expected returns on both horizons.

Once extreme valuations are in place, the losses that follow have everything to do with that overvaluation, and nearly nothing to do with the behavior of interest rates. Indeed, the worst market losses across history have been associated with relatively low short-term interest rates during the collapse and the absence of any material hike in interest rates at all as the collapse unfolds. Investors have convinced themselves to tolerate historic valuation extremes, confident that stocks can’t fall unless interest rates rise. They’ve walked right into this setup because they don’t recognize it, and neither central bankers nor the investment profession appear interested in admitting the increasingly pressing risks that they themselves have been complicit in creating.

Ultimately, the intentional encouragement of speculation by central banks in recent years has created a situation from which no resolution is possible other than 0-2% investment returns on a 10-12 year horizon, and a market collapse over the completion of the current market cycle.

We currently estimate that the total return on a conventional portfolio mix of stocks, bonds and Treasury-bills is likely to average scarcely 1.5% annually over the coming decade. Ironically, however, the advance to extreme valuations (and correspondingly poor long-term return prospects) has encouraged pension administrators to underfund future liabilities, on the belief that high realized past returns are representative of future outcomes.

Does anyone really believe that extreme yield-seeking has not already played out in the stock and bond markets? When investors say “there’s no alternative” to overpriced, risky assets, do they not recognize that virtually every investor on the planet has acted on that same belief? Do they not recognize that the absence of yield on short-term money is exactly why stocks and bonds are now also priced to deliver next to nothing over the coming 10-12 years? Do they not recognize that past realized returns have stolen from future prospective returns? Do they not understand that for future prospective returns to normalize even moderately over the completion of the current market cycle (as they have done over the completion of every market cycle in history), much of those past realized returns must be wiped out?

The greatest danger comes when investors insist on speculating even after market internals have deteriorated and momentum has rolled over. Following a long period of speculative success, they may be tempted to ignore latent risks, and to keep speculating on the time-delay between the emergence of latent risks and their abrupt expression. They fall victim to the delusion that, in the words of Citigroup’s Chuck Prince just before the global financial crisis, “as long as the music is playing, you’ve got to get up and dance.” No, you don’t.

Market conditions continue to be characterized by the likelihood of extremely poor long-term and full-cycle outcomes, with expected 10-12 year estimated S&P 500 nominal total returns in the 0-2% range, negative expected real returns on both horizons, and the continued likelihood of a 40-55% interim market loss over the completion of the current cycle; a decline that would represent only a typical run-of-the-mill cycle completion, based on valuation measures most tightly related with actual subsequent market returns across history.

The worst market declines typically emerge from conditions where value-conscious investors have been defensive for quite some time, and where trend-following speculators have been rewarded for quite some time.

Speculators seem willing to imagine that the Fed has created a permanently high plateau, but historically-informed investors should know better.

The single most important quality that investors can have, at present, is the ability to maintain a historically-informed perspective amid countless voices chanting “this time is different” and arguing that long-term investment returns have no relationship to the price that one pays.

The danger of constant fire suppression is that it fosters the illusion that the entire forest is a controllable object, while actually weakening its capacity for resilience. Likewise, the danger of relentless Fed intervention is that it fosters the illusion that the financial markets are under the tight control of monetary policy, while encouraging malinvestment that amplifies the severity of the ultimate consequences. Nothing has been learned from 2000-2002 and 2007-2009, when even persistent and aggressive easing was incapable of holding back the inevitable collapse of malinvestment. The market plunges that completed those market cycles essentially represented the mass recognition by investors that they had badly miscalculated. Each successive bubble encourages them to forget that lesson.

With the S&P 500 Index at the same level it set in early-November 2014, and the broad NYSE Composite Index unchanged since October 2013, the stock market continues to trace out a massive arc that is likely to be recognized, in hindsight, as the top formation of the third financial bubble in 16 years. The chart below shows monthly bars for the S&P 500 since 1995. It's difficult to imagine that the current situation will end well, but it's quite easy to lose a full-cycle perspective when so much focus is placed on day-to-day fluctuations.

When a given behavior stops being reinforced, one might expect the behavior to be abandoned. Instead, and particularly when no substitute behavior is available, you’ll actually see an initial “extinction burst” - a nearly frantic increase in the frequency and the intensity of the behavior. Consider central bankers.

The completion of every market cycle in history has taken the most reliable equity valuation measures toward or below their historical norms - levels associated with subsequent total returns approaching 10% annually. That includes two cycle completions since 2000, as well as cycles prior to 1960 when interest rates regularly hovered near present levels. After an unusually extended speculative half-cycle, we doubt that the completion of the present cycle will be any different. It has taken the third speculative bubble in 16 years to bring the nominal total return of the S&P 500 since March 2000

Last week, the most historically reliable equity valuation measures we identify (having correlations of over 90% with actual subsequent 10-12 year S&P 500 total returns) advanced to more than double their reliable historical norms. When valuations have been near those historical norms, the S&P 500 has generally followed with average nominal total returns of about 10% annually. In contrast, current valuations are associated with expected 10-12 year total returns of about zero, with negative expected returns on both horizons after inflation.

If market internals were to improve markedly (we’re nowhere near that outcome at present), the immediacy of our downside concerns would ease significantly. Here and now, a measurable spike in financial stress has occurred despite an S&P 500 that is still within 10% of its all-time high, but in the context of wicked overvaluation, poor market internals, and weakness in leading economic data. All of those, as I observed at both the 2000 and 2007 peaks, are features that have historically been associated with market collapses. Present conditions don’t imply the forecast of a market crash. But

When a widely-identified support level gives way at rich valuations, in an environment where poor market internals convey a shift toward risk-aversion among investors, the break can behave as a common trigger for concerted attempts to exit.

Historically, increases in the Fed’s balance sheet have only been positively associated with increases in the S&P 500, on average, when the S&P 500 was already in an uptrend and investors were already inclined to speculate.

As we observe in the U.S., central bank easing in Japan only reliably benefits the stock market, on average, when market action is already favorable, indicating a preference among investors to accept market risk. Once market internals deteriorate, central bank easing fails to provoke speculation, on average. The gas pedal is useless when the spark plugs are gone. Aside from short-lived, knee-jerk responses, there is no historical basis to assume that central bank easing will promptly encourage fresh speculation in an overvalued market that has lost internal support. To the contrary, as investo

With extreme valuations coupled with uniformly unfavorable market internals, the market return/risk classification we identify here could not be more hostile. In particular, relief rallies under current conditions tend to be truncated by wicked losses. My use of such strong words here is not hyperbole; it’s a reflection of the skewed return/risk profile that has historically been associated with market conditions similar to those we observe at present.

Since October, the economic evidence has shifted from supporting a growing risk of recession, to a guarded expectation of recession, to the present conclusion that a U.S. recession is not only a risk but an imminent likelihood, awaiting confirmation that typically only emerges after a recession is actually in progress.

Our expectations for a global economic downturn, including a U.S. recession, have hardened considerably in the past few weeks, with a continued expectation of a retreat in equity prices on the order of 40-55% over the completion of the current cycle as a base case. The immediacy of both concerns would be significantly reduced if we were to observe a shift to uniformly favorable market internals. Last week, market conditions moved further away from that supportive possibility.

At speculative extremes, recent history always temporarily belongs to the reckless herd that has ignored concerns about valuation and risk at every turn. Fortunately, the future has always belonged to those who take discipline, analysis, and the lessons of history seriously. On the basis of the valuation measures most strongly correlated with actual subsequent market returns (and that have fully retained that correlation even across recent market cycles), current extremes imply 40-55% market losses over the completion of the current market cycle.

As we look forward to 2016, to following through on our investment discipline over the completion of the current market cycle and beyond, a few recent market comments will serve as a detailed review of our present market and economic outlook.

In recent quarters, I’ve remained adamant that the immediate first step of the Federal Reserve in normalizing monetary policy should have been to reduce the size of its balance sheet. The Fed’s failure to prioritize that first step, in the apparent desire to maintain an aggrandized role in the U.S. financial markets, has significantly increased the risk of a collapse from the speculative extremes the Fed has created in recent years. Given the increasing risk-aversion evident in market internals, we doubt that even a reversal of last week’s rate hike would materially reduce that prospect.

Over the past several years, yield-seeking investors, starved for any “pickup” in yield over Treasury securities, have piled into the junk debt and leveraged loan markets. Just as equity valuations have been driven to the second most extreme point in history (and the single most extreme point in history for the median stock, where valuations are well-beyond 2000 levels), risk premiums on speculative debt were compressed to razor-thin levels. By 2014, the spread between junk bond yields and Treasury yields had fallen to less than 2.4%.

In the presence of obscene valuations, deteriorating market internals, widening credit spreads, and tepid economic activity on the most historically reliable measures, we presently observe the same essential syndrome of risk factors that allowed us to accurately anticipate the 2000-2002 market collapse and recession, as well as the 2007-2009 global financial crisis. Emphatically, a return to risk-seeking behavior among investors, as evidenced by a clear improvement in market internals across a broad range of individual stocks, industries, sectors and security types (including debt securities

The atmosphere is getting thin up here, and every ounce counts triple when you're climbing in rarefied air. While near-term market dynamics are more likely to be impacted by Friday’s employment report than any other factor, our broad view remains that stocks are in the late-stage top formation of the second most extreme episode of equity market overvaluation in U.S. history, second only to the 2000 peak, and already beyond the 1929, 1937, 1972, and 2007 episodes, not to mention lesser extremes across history.

Two types of dispersion are increasingly apparent in market dynamics here. The first type of dispersion is between leading measures of economic activity and lagging ones. The second is dispersion in market internals, particularly observable in a continued narrowing of leadership to a handful of “winner-take-all” stocks, while broader measures of market action across individual stocks, industries, sectors, and credit spreads show persistent divergence that suggests increasing risk-aversion among investors.

Investors have a habit of pointing to past bubbles as if they have actually learned something, even when they are in the midst of another one.

Investors have experienced a great deal of whiplash in recent months. After a rapid but relatively contained retreat in August and September, the stock market has rebounded to within 2% of its May record high. Only weeks ago, investors were concerned about economic deterioration. As of Friday, strength in nonfarm payrolls has suddenly convinced investors that a December rate hike by the Fed is all but certain.

Historically, when the stock market has deteriorated internally following a recent period of overvalued, overbought, overbullish conditions, we know that market outcomes have been negative on average. But what if the S&P 500 Index falls below its 200-day moving average, and then recovers above it again? Doesn’t that recovery signal a resumption of the bull market? The answer largely depends on market internals.

Wide market cycles have been a central feature of the stock market across history. Even a run-of-the-mill bear market decline typically wipes out more than half the gain of the preceding bull market.

One of the central themes I’ve emphasized over the past year is the critical importance of using market internals as a gauge of investor risk-seeking and risk-aversion. Over the long-term, investment returns are driven by valuations – particularly on a 10-12 year horizon. Over shorter horizons, and more limited portions of the market cycle, the primary driver of investment returns is the preference of investors to seek or avoid risk.

One of the important investment distinctions brought out by the speculative episode of recent years is the difference between the behavior of an overvalued market when investors are risk-seeking, and the behavior of an overvalued market when investors shift to risk aversion. The time to be tolerant of bubbles is when the uniformity of market internals provides clear evidence of risk-seeking among investors.

With the S&P 500 within about 8% of its highest level in history, with historically reliable valuation measures at obscene levels, implying near-zero 10-12 year S&P 500 nominal total returns; with an extended period of extreme overvalued, overbought, overbullish conditions replaced by deterioration in market internals that signal a clear shift toward risk-aversion among investors; with credit spreads on low-grade debt blowing out to multi-year highs; and with leading economic measures deteriorating rapidly...

Risk-seeking among investors can often defer the immediate consequences of extreme valuations, while vertical losses can suddenly emerge when extreme overvaluation is joined by increasing risk-aversion among investors (as evidenced by deterioration in broad market internals). In any event, investors should expect market overvaluation or undervaluation to be reliably “worked off” within a period of about 12 years, on average.