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The S&P 500 is in the mid-800s now, and has been as high as 1,000 and as low as 750 in the last three months. It could easily retest 1,000 or 750 within the near future as it seeks to break out of its range. A downside breakout is a possibility, which could see the 600s as a new low (even the 400s in a more dire case).
The principal fundamental logic for a possible dive to 600 or less is based on Standard & Poor's projection of 2009 S&P 500 "as reported" earnings of $42.24, and 80+ years of historical P/E ratios based on "as reported" earnings.
Earnings
These are the quarter-by-quarter 2009 estimates by S&P as of 12/31/08:
These S&P earnings estimates are a slight increase from the trailing 2008 earnings, and are subject to downward revision, if like other analysts, they adjust to increasingly bad economic news. Operating earnings make P/Es look OK, but real world is "as reported."
Citi analysts say that earnings are less than half the way down from peak to trough.
In addition to being possibly too optimistic, the 2009 estimates are not as low as the earnings trough of 2001 and 2002. Given all the current turmoil, we would think the 2001 earnings level would be a reasonably plausible outcome.
Price Earnings Multiples
In a prior publication, we established that, after eliminating the extreme 10% high and 10% low monthly P/E ratios for the past 80+ years, P/E ratios based on "as reported" earnings tend to fall into the range 10 to 20, with 15 as an approximate average and median.
Generally, a P/E above 15 would represent expected above-average earnings growth prospects (or persistent low interest rates), while a P/E below 15 would represent expected below-average earnings growth prospects (or persistent high interest rates).
Here is chart of quarterly "as reported" earnings P/E ratios for the index from 1936 through the first half of 2008. The average P/E there is 15.79. Removing the extremes moves the average back to slightly less than 15 for this and longer studies.
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