If you’re uncertain as to the central rationale being made by the bulls for this overvalued equity market getting even more overvalued, here’s the argument in a nutshell:
 

Low levels of both core inflation and interest rates suggest that the normalized P/E on stocks should be in the upper teens (18 to 19), not the historical average of 15 times.

Consensus earnings estimates for the S&P 500 for 2010 have been moving up in recent weeks, a process that will likely accelerate when third- and fourth-quarter results exceed expectations. Therefore, 18 times $75 gets us to 1350, 25% higher than we are now.

My argument against this thinking is as follows:

While historically it’s true that 18 to 19 P/Es are the norm for the low inflation/low interest rate scenarios, I believe that the extraordinary times we're currently in (huge government involvement in the economy, unresolved regulatory issues, questions regarding the accuracy of China's growth, etc.) warrant a diminution of the 18 to 19 P/E justification.

Hence, the average times P/E of 15 is more appropriate.

As for the earnings argument, large- and mega-cap results (S&P 500 operating earnings) may come in as noted, however, the sustainability of the global economy (the handoff from government to business -- capital expenditure and inventory build -- to the consumer) isn’t a done deal.

The reason large- and mega-cap results may come in as noted is discussed in V-Shaped Rally ≠ V-Shaped Recovery.

And the fact that it’s not a done deal led to comments on my blog referencing David Malpass, president of Encima Global, and concerns regarding mid-, small-, micro-, and lower-cap companies.

Accordingly, the impact to consumer wages and psychology may be more burdensome than the bulls believe.

To illustrate just how bullish the bulls are, here’s how investors will earn an additional 15% return in stocks from now until the end of this year:
 

• 18 times $75 = 1350
• 1350 minus a conservative discount rate of 10% = 1215
• 1215 minus yesterday’s close of 1060 = 155
• 155 divided by 1060 = 14.6%

There are two useful elements in the points noted above: The valuation arguments for and against the overall US stock market, and the size and style perspective on stocks.

The first point requires investors to decide which side of the argument they buy into. While I’ve written on this numerous times, the new news is what David Malpass and I discussed the other day regarding the US consumer’s ability to rebound and help put the US and global economy on a sustainable recovery path. On this I have my doubts.