Could this Warren Buffett indicator suggest market declines are ahead?

It used to be said that when America sneezes, the rest of the world catches a cold.

While there are plenty of exceptions to every rule, there is a reason why most traders and investors in Australia begin each working day by taking a look at what happened on Wall Street overnight.

On Tuesday, when the market resumed trading after the Easter break, the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) promptly lost 80 points, or 1.6%, to close at 5,004.

The fall take the market back to the psychologically important 5,000-point level which will no doubt have many investors pondering whether the market will retest the recent February low of 4,707.

A Bigger Worry!

While near term market movements are anyone’s guess, a more important question for long term investors – such as those with superannuation and hoping to retire comfortably – is which direction the market is headed over the next decade…

While the following research relates to the US stock market, its influence over global markets should not be underestimated.

Fund manager John Hussman recently drew attention to the ratio of Market capitalisation to GDP, a measure that Warren Buffett has previously described as “probably the single best measure of where valuations stand at any given moment.”

Based on Hussman’s research he suggests that US “valuations are twice their historic norms”!

What’s more, Hussmann’s view is that a reversion to the mean will require the S&P 500 to trend to a level below today’s level by 2028. This expectation is based on his observations of long term, historic norms and cycles.

While Hussman’s 12-year prediction is hardly a pleasant thought, the actual percentage decline in the market would be relatively small. With dividends included, the total nominal return from the S&P 500 would be a positive 2% gain per annum.

Foolish takeaway

Hussman’s observations should reminder investors that dividends and not just capital appreciation play a significant role in overall investment returns.

While Hussman’s estimates may prove to be wrong, should the following decade turn out as he envisages and if Australia’s market followed suit, a portfolio of holding high-yielding stocks such as Telstra Corporation Ltd (ASX: TLS) and Commonwealth Bank of Australia (ASX: CBA) may at least provide investors with a positive return.

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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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