The two axes are scaled at 16-to-1 so when the lines cross, the market's P/E Ratio is 16. I think we're at an interesting point where the stock market's P/E Ratio doesn't tell us much. The market has clearly sensed signs of recovery even though earnings are still plunging. As a result, the market's P/E Ratio has jumped about 50% since March.
Does this mean that stocks are valued 50% more favorably? Not at all. I think the market is getting a better sense of where earnings will bottom. Analysts currently see earnings reaching a trough of about $38 for the third quarter. I can't say if that's right but it does seem reasonable.
The fourth quarter of 2008 was awful so once we get that behind us, the trailing earnings picture will look much better. According to S&P, AIG took out over $5 all by itself. The current outlook is that the S&P 500 will earn $54 for 2009. That strikes me as high but not out of reach.
For 2010, Wall Street sees earnings of $73.56. At 16 times earnings, that means an S&P 500 at 1177 which is about 25% higher than we are now.One other point to note: Analysts have not been very good at getting earnings right. In a few weeks we'll close the books on Q2. One year ago, Wall Street was expecting Q2 earnings of $26.73. Now they're expecting just $13.49.