Betting on a 30% drop

    Today's investors face that daunting fate. Dividends won't help much: the current yield is just 1.9%, versus an historic average of 4.75%.

    High multiples, like the PE we're seeing now, explain why equity performance has been underwhelming for almost two decades. The late 2008 period marked the first time since 1992 that the Shiller PE fell below 20. Investors who bought into the S&P at around today's PE in early 1992 made paltry returns of between 5% and 6%, including dividends. And that's after the huge, 45% rebound in the past 18 months.

    It's indeed possible that stocks are correctly priced, and the Shiller PE stays where it is now. In that case, investors will get mid-single-digit returns. The most likely outcome: They won't be satisfied with those gains, and hence will force the market to provide much better returns by the only route possible -- by severely pushing down prices.

    The best bet is that the S&P drops around 30%, to the 800-range it hit in March of 2009. Then, the PE slipped below 14, and yields were almost 4%. For the first time in almost two decades, stocks became a bargain, and that's what it will take to make them a bargain again.

    Sure, the economy can, and probably will rebound. But that provides no escape from this quandary. We could easily get better growth AND lower stock prices. Indeed, lower prices are the only way out of this box.