The S&P 500 has now trended over its 10-month moving average for 2 years and volatility recently hit its 2013 low. Investors have tuned Jeremy Siegel in and Jeremy Grantham out. However, along with optimism and a fair amount of market expansion, there has been little “real” earnings growth.

When discussing the market’s value based on things like earnings — I admit to being a bit of a wet blanket. Back in August of 2012, when Istarted a series looking at the market valuation using the S&P 500 (SPY) and focusing on Shiller’s Cyclically Adjusted Price-to-Earnings (CAPE), I felt that earnings had been running above trend and that reversion to the mean would bring earnings back to its long-term path. At that time I made what seemed to be a straightforward argument:

• Recent earnings are significantly above the long-term earnings trend (year 1926 to present). Therefore expect future projected earnings to slow more than market participants expect.
• Based on a slowing earnings environment and a recent market multiple of 15.6X, the current market valuation (in August 2012) looked fair-to-overvalued.

With the market being up 31% over that time period and operating earnings per share up only 3.6% (including share buybacks and inflation), being right on a slowing earnings front hasn’t mattered nor dampened market enthusiasm. The rest of this note will dive into those earnings and whether current expectations are rational.

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