The EPS Theory : A Divergence Between The Economy & Market

Since before the MAR 9th, 2009 market bottom everyone has noted the economy's degrading fundamentals while the market has since soared upward into "unsustainable", "unreasonable" & "disbelievable" levels.

"Really?", I wonder.

What model works where observations match predictions?
The"correct" model does.

Despite growing unemployment not expected to have meaningful improvement until mid 2010...
Despite ongoing huge months of inventory of existing homes for sale...
Despite the Damocles sword of commercial real estate defaults dangling overhead...
Despite vicious arguments between inflation & deflation...
The market keeps rising.
And rising.
And rising.

Why?

There is a growing divergence between the corroding fundamentals of the economy (misguidingly focused on unemployment) and the forgotten foundation of the market: Earnings drive the market but have little bearing on the economy.

Model A: 3% Unemployment
Let there be a labor force of 1,000 with 3% unemployed job seekers, equaling 970 laborers with jobs and 30 laborers without jobs.
The 1,000 labor force lives amongst a population of 2,000 total consumers.
Total annual consumption of the 2,000 consumers equals $20,000 across corporations with reportable earnings.
Think of Retail Sales as Revenues.
The Wages of the 970 employed, at $15, equals $14,550.
Think of Wages as Expenses.
Revenues minus Expenses equal Earnings.
$20,000 - $14,550 = $5,450 of reportable corporate Earnings

Model B: 10% Unemployment
Let there be a labor force of 1,000 with 10% unemployed job seekers, equaling 900 laborers with jobs and 100 laborers without jobs.
The 1,000 labor force lives amongst a population of 2,000 total consumers.
Total annual consumption of the 2,000 consumers drops to $18,950 across corporations with reportable earnings.
The Wages of the 900 employed, at $15, drops to $13,500.
$18,950 - $13,500 = $5,450 of reportable corporate Earnings
WOW!
Despite the massive wailing & gnashing of teeth over 10% unemployment - and - despite the natural drop in Annual Retail Sales (Revenues) that follows a drop in employment (Expenses), it is possible to have equal (maybe even greater!) Earnings.

Model C: Bazillions Unemployed
Let there be 900 laborers with jobs and a bazillion!! laborers without jobs.
(You're about to see why the unemployed really doesn't matter to the market).
The 900 labor force lives amongst a population of 2xBazillion!! total consumers.
Total annual consumption of the 2xBazillion!! consumers also equals $18,950 across corporations with reportable earnings.
The Wages of the 900 employed, at $15, remains at $13,500.
$18,950 - $13,500 = $5,450 of reportable corporate Earnings
WOW!
WOW! Oh, WOW! Oh, WOW!
Despite the chaos & anarchy of a Bazillion!! unemployed - coupled with - what would be an amazing per capita drop in the standard of living as evidenced by the Annual Retail Sales (Revenues) with employment (Expenses) still at 900, it is still amazingly possible to have equal Earnings.

So...!
Somewhere between the harsh actuality of Model B and the ridiculousness of Model C lies the answer as to the mechanics of "How" we have this huge disparity between "reality" (defined by unemployment/housing/debt/inflation/deflation) and the rise in the market.

Unemployment doesn't affect earnings!
Unemployment is not an expense to be subtracted from revenues.
Pay attention to Actual Retail Sales (Revenues).
Pay attention to Actual Employment (Expenses).
From those an approximation of Earnings can be derived.