We should begin with an observation. If one examines the historical data, there is a very weak relationship between year-to-year changes in earnings and year-to-year changes in the stock market. This lack of relationship partly reflects the fact that stock prices often recover from recessions quite briskly well before earnings advance, and stock prices often collapse well before earnings do. But even accounting for these leads and lags, the relationship between cyclical fluctuations in the S&P 500 and S&P 500 earnings is simply not very strong.
My concern at present is emphatically not simply a concern about the near-term direction of earnings, or any assumption that stocks must closely follow earnings. Rather, my present concern is much more secular in nature. It can be expressed very simply: investors are taking current earnings at face value, as if they are representative of long-term flows, at a time when current earnings are more unrepresentative of those flows than at any time in history. The problem is not simply that earnings are likely to retreat deeply over the next few years. Rather, the problem is that investors have embedded the assumption of permanently elevated profit margins into stock prices, leaving the market about 80-100% above levels that would provide investors with historically adequate long-term returns. An equivalent way to say this is that stocks are currently at levels that we estimate will provide roughly zero nominal total returns over the next 7-10 years, with historically adequate long-term returns thereafter.