As we get into the heart of earnings season, investors will be watching the quarterly results in order to predict the market's reaction, both short- and long-term. Earnings reports help us gauge the health of individual companies, as well as the broader macroeconomic trends across industry sectors. At the same time, it is important to note that stock price action will often move seemingly at odds with earnings results. This because, at least in the short term, markets do not trade on valuation alone. Moreover, valuation itself is a tricky game.

Henry Blodget explained some of the difficulties inherent to valuation in a 2004 article:

A share of stock is, in theory, worth the "present value of future cash flows" attributable to the share. (In practice, a share is worth what someone will pay for it, but leave that aside for a moment.) Given the confidence with which some commentators cite the theory, a casual observer might assume that the "present value of future cash flows" is an indisputable number, akin to a price tag on a can of soup. In reality, however, it is not a number but an argument, and, in most cases, it is a surprisingly imprecise argument, with a wide range of reasonable conclusions.

Blodget goes on to discuss the complexity of evaluating future cash flow given the uncertainties of the broader economic environment, future earnings, and, particularly, interest rates. As he says,"Over the long haul, thankfully, valuation does matter: The market is not random, stock prices do tend to regress to long-term means, and long-term investors are better off buying when stocks are cheap. As discussed in a previous piece, however, the "long term" is long (decades, not years), and valuation is not a particularly helpful prediction tool over timeframes of three months to a couple of years (not worthless—just not particularly helpful)."

In this light, we can consider the prior two quarters of earnings results, post meltdown, that led to continuation of our remarkable rally. At no time since the financial crisis began have company earnings been particularly good. In fact, across the board, both revenue and earnings have been down drastically. Remaining profits often have been the result of cost-cutting, or in the case of the larger banks, profits from trading with taxpayer dollars. Moreover, when it comes to banks and REITs, financial results have not been marked-to-market. Therefore there are certainly enormous unreported liabilities throughout the system. As in many billions of dollars worth. The media has generally reported that this sustained rally has been due to improving economic conditions. Perhaps to a degree this is the case.