Since bottoming in March, stocks have moved sharply higher, leaving many wondering whether further gains are possible. Earnings estimates from Standard & Poor’s show that the market has already priced in a robust economic recovery and has little upside unless a bubble in stocks develops.
From their peak, earnings in the stocks that make up the S&P 500 have fallen by more than 90 percent. Given recent economic news, earnings should improve from this point, and analysts are growing increasingly optimistic.
For 2009, forecasters think earnings will rise by 9 percent from the low levels seen in 2009. This is based on an optimistic assumption that earnings will grow by 50 percent in the fourth quarter compared with the third quarter.
History shows that this is unlikely since the fourth quarter often shows a decline when compared with the previous quarter. While this time may very well be different, chances are that it will not be and gains will be less than expected.
Analysts’ hopes continue into 2010 when, earnings are expected to grow by 35 percent. For an individual company, 20 percent growth is considered high and only the best companies achieve that level. Exceeding that for the entire stock market would be considered craziness in ordinary times.
But, even if earnings growth meets expectations, the current valuation of the market is near its historic average of 15. The P/E ratio is about 20 based on the 2009 estimates, and 15 based on the 2010 estimates.
From here, the stock market can go higher if earnings grow faster than they ever have in history or investors become irrational. While either is possible, neither is a safe bet.
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