As the markets push once again into record territory the question of valuations becomes ever more important. While valuations are a poor timing tool in the short term for investors, in the long run, valuation levels have everything to do with future returns.

Yesterday, Doug Kass penned an interesting note on the current market advance:

“Consistently advancing and uninterrupted rising stock prices have a way of spreading fallacious arguments not grounded in fact. Here are some recent examples of that meme — namely, of an earnings-driven market.

This is the new meme, but it increasingly resembles ‘Group Stink.’

Contrary to the pablum delivered by many in the business media, the rise in stocks over the last 12 predominantly has been a valuation-driven story, just as it was in 2016 when S&P 500 profits were up 5% and the S&P Index rose by about 11%.

And going back even further, since 2012 S&P earnings have risen by 30% compared to an 80% rise in the price of the S&P lndex.”

The current belief is the market will surge even higher as a result of corporate “tax cuts” which further boost corporate profits. While the estimates of higher profits via tax cuts is obvious, the question remains as to how much of any tax cut received by corporations is already priced in? More importantly, is the sustainability of the growth of earnings going forward.

John Hussman, via Hussman Funds, once penned:

“I’ve noted frequently that after-tax corporate profits as a share of national income are about 70% above historical norms; that these profit shares are heavily mean-reverting and strongly (inversely) associated with subsequent profit growth over the following 3-4 year period; and that the current surplus of corporate profits is the mirror-image of corresponding deficits in household and government savings (a relationship detailed in prior weekly comments). Recent profits data, as well as the entire historical record, are tightly explained by these factors.

Notably, this data is derived from the national income accounts computed by the Bureau of Economic Analysis, and it’s worth understanding how the BEA computes profits. Specifically, the BEA points out, ‘Because national income is defined as the income of U.S. residents, its profits component includes income earned abroad by U.S. corporations and excludes income earned in the United States by foreigners.’”