March 2012 Research Note, "What Price Earnings?"
The earnings recovery from the Great Recession of 2008-2009 has continued in recent quarters. Standard & Poor's 500 (S&P 500) operating earnings in 2011 exceeded the peak earnings achieved in 2007. However, the price of the S&P 500 remains well below the peak level of 1565 achieved in October 2007 - 200 points above the current level. At the closing price of 1363 on March 2, the S&P 500 was valued at approximately 14x operating earnings. Should investors expect that the S&P 500 is poised to recover the 2007 level?
While at first glance a lower valuation would seem to indicate that stocks are undervalued and should be purchased, a closer look at valuation provides a less clear signal to buy. ThisResearch Note provides a longer term perspective on equity market valuation and argues that there may be less room for improved valuation than what is suggested by shorter term measures.