Since the election, markets have accelerated the pace of the advance as shown in the chart below.
The advance has had two main story lines to support the bullish narrative.
- It’s an earnings recovery story, and;
- It’s all about tax cuts.
There is much to debate about the earnings recovery story but as I showed previously, and to steal a line from my friend Doug Kass, this “new meme increasingly resembles ‘Group Stink.’” To wit:
“Despite many who are suggesting this has been a ‘rational rise’ due to strong earnings growth, that is simply not the case as shown below. (I only use ‘reported earnings’ which includes all the ‘bad stuff.’ Any analysis using “operating earnings” is misleading.)”
“Since 2014, the stock market has risen (capital appreciation only) by 35% while reported earnings growth has risen by a whopping 2%. A 2% growth in earnings over the last 3-years hardly justifies a 33% premium over earnings.
Of course, even reported earnings is somewhat misleading due to the heavy use of share repurchases to artificially inflate reported earnings on a per share basis. However, corporate profits after tax give us a better idea of what profits actually were since that is the amount left over after those taxes were paid.”
“Again we see the same picture of a 32% premium over a 3% cumulative growth in corporate profits after tax. There is little justification to be found to support the idea that earnings growth is the main driver behind asset prices currently.
We can also use the data above to construct a valuation measure of price divided by corporate profits after tax. As with all valuation measures we have discussed as of late, and forward return expectations from such levels, the P/CPATAX ratio just hit the second highest level in history.”
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