A look at history shows that a strong rebound in stock markets is not unusual and excellent returns are available to those who survive rough patches.

Since 1871, the three worst ten-year returns for stocks (here I am taking the S&P 500 as it is the index for which most data is available) have ended in the years 1974, 1920, and 1978. These were followed, respectively, by real, after-inflation stock returns of more than 8%, 13%, and 9% over the next ten years. In fact, for the 13 ten-year periods of negative returns that stocks have suffered since 1871, the next ten years gave the investors real returns that averaged over 10% per year.

The S&P 500 has suffered a year-to-date loss at 4.7%. The index is 57.1% above the March 9, 2009 closing low, which is 32.1% below the peak in October 2007. The decline from the interim high on January 19 is 7.6%.

The S&P 500 lows in 1974 and 2002 marked the beginning of sustained recoveries. The Dow low in 1929 failed 11 months later. From its low on March 5, the current S&P 500 recovery has outperformed the 1974 and 2002 rebounds over the equivalent period, and it has far surpassed the 48% recovery in the 1929 Dow. Will it prove to be resilient this time?

Dow yield versus Treasury yield

Currently, the 10-year Treasury note in the US is yielding 3.84% versus the Dow?s dividend yield of roughly 2.6%. One of the arguments for stocks at the bottom of the bear earlier in 2009 was that they were yielding more than the Treasuries. This had not happened in nearly 50 years. The consensus for 2010 is that stocks will rise (dividend yields lower) while the 10-year yield will rise as well. Based on historical evidence, stocks have to go up much higher (thus causing dividend yields to turn lower) before we can call time out for the current stock market rally.

For the last nine months, global equities appear to have been in a twilight zone. This is the phase towards the end of most recessions when share prices turn upwards even though corporate earnings are still falling. The twilight zone ends when the global ?earnings recovery? begins. I expect this to happen imminently.

Corporate profits outlook

I am expecting non-financial corporate profits to grow by around 30% in 2010. Muted revenue growth, as implied by nominal GDP forecasts, does not necessarily mean the profit recovery will be weak. In fact, I believe that low revenue growth can still drive a strong recovery in earnings.

To understand why, we need to consider what is happening to corporate costs. Companies have been cutting costs more than ever before. The combination of rising revenues and low costs should provide an opportunity for companies to benefit from positive operating leverage. For example, in 2009 I estimate that non-financial revenues contracted by 2% and costs fell by 1%. These changes should drag down profits by about 25%. In 2010, I believe the world?s muted nominal GDP forecast will support revenue growth of just 4%. But I also think companies are in a position to hang on to some of their cost savings, so the cost base should rise by less than revenues, at about 3%. Given the low starting point, the associated operating leverage should drive a 30% increase in profits.

After falling by 55% since peak levels in late 2007, global EPS looks to be bottoming out. The percentage increase in earnings over the next year and a half should be strong. Global equities should perform well enough during this period, but they should grind higher. They surged forward during the ?twilight zone?. The prospects of a mid-cycle slowdown will offer new challenges to global equity markets in mid-2011.

But for now, I believe that the combination of reasonable valuations, imminent earnings recovery, and low interest rates means that it is too early to turn cautious. I would see further setbacks as a buying opportunity.

(Concluded)

The author is a Wharton Business School MBA and CEO, Global Money Investor