30 SEP 2009, Wednesday

1. Above is a historical chart of the SP500 and it's Price to Earnings ratio which is a traditional valuation model. It shows how much people are willing to pay for the stock of companies based on what the company is earning. Notice anything interesting there?
2. Twelve-month trailing earnings as of the first quarter 2009 were a mere $6.86 for the S&P 500 making for a P/E ratio of 154. According to Standard and Poor's, these earnings are estimated to rise to $7.51 in the second quarter, and $7.61 in the third quarter. Then they're expected to jump to $39.35 in the fourth quarter and $43.58 in the first quarter 2010. Based on this last figure the P/E ratio will decline to 24.
3. Historically the normal range for this very P/E ratio — based on 12-month trailing GAAP earnings — has been between 10 (undervalued) and 20 (overvalued). Hence even if the corporate sector will see the estimated jump in earnings, the stock market is still very expensive.
4. Classic stock market valuation metrics show that this is a highly overvalued market. And overvalued markets can stay overvalued for a long time and even become more overvalued.
5. Earnings season starts again in 2 weeks so we'll see what happens. The last two resulted in two big uplegs despite companies reporting big year over year losses...yet, the market scorched upward. In between them, the market was relatively flat to mild up. This earnings period may be a catalyst. We'll see.