Our current assessment is that the US stock market averages (based on S&P 500 index) are priced at fair valuation, taking into account the recent decline in the index and our expectation that earnings estimates will be adjusted in the coming months. Surprisingly, earnings estimates have continued to move higher over the past several weeks, despite expectations for a possible global slowdown in growth. As of April 1, 2010, earnings estimates were $78.15 for 2010, a 37% increase over final 2009 numbers ($56.86). As of June 30, 2010, earnings estimates increased to $81.73 for 2010 and $94.84 for the 2011 calendar year, increases of 44% and 16% year over year respectively – still too optimistic in our opinion.
If we make a reasonable yet optimistic assumption of 20% earnings growth this year and 16% earnings growth next year – earnings estimates would be roughly $68.23 for 2010 and $79.15 for 2011, below current expectations. Using a price-earnings multiple of 15 (long-term average valuation), we calculate valuations of roughly 1,023 for the S&P 500 Index for 2010 (near end of June levels) and approximately 1,187 for 2011. We believe markets are adjusting to this new fundamental reality and this is likely why the markets have declined in recent weeks. Currently, second quarter earnings releases are in full swing and company comments will give us a good indication of earnings prospects for the second half of the year.
