Valuation Argument Getting Weaker

The news of late regarding earnings, the global economy and the EU have been awful but the market has managed to hang in.  The S&P 500 still sits on a respectable gain for the year even after the recent downdraft. The best thing the market has had going for it is that valuations are reasonable. Lately, we have been seeing big earnings warnings and the earnings expectations that these valuations hinge on might soon come into question.

Expectations have been for roughly $105 in S&P 500 earnings for 2012. At a modest 14 times earnings that would equate to the S&P 500 at 1470. Even at at $95 a 14 multiple would put the S&P 500 at 1330, not far from where we are currently trading. The point being that earnings estimates have some room on the downside before the markets valuation would become a negative.

I do not expect to see the type of earnings decline we saw in 2008-2009. The housing bubble resulted in excesses in the economy and at corporations that are not present currently. That said, given the size of recent earnings warnings and slowing economies around the world a sizable decline in earnings is still possible.

The bottom line is that the valuation argument for the S&P 500 is getting weaker. Earnings estimates are almost certain to decline but the magnitude of the decline is the key. The bulls still have some cushion in regards to valuation but its getting thinner.

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