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S&P Watch: Higher Earnings in Coming Months?


Playing the valuation game means heeding the message of the market.

"Our economics department is forecasting a sluggish recovery in GDP. It will turn positive in the third quarter but grow by only 1% or 2%. Given lackluster profit expectations, our 6-to-12-month S&P outlook is 950 to 1,050. Goldman is forecasting S&P 500 earnings before provisions of $63 in 2009 and $71 in 2010. Regardless of the number, there is a discontinuity in the data.

"Some S&P 500 companies have disappeared, and recent quarters have seen extraordinary write-offs. There will be a major inflection point for earnings in the third or fourth quarter. Our analysts believe risk may be to the upside -- that is, profits may grow faster than previously forecast."

-Abby Joseph Cohen, senior US investment strategist at Goldman Sachs (GS), quoted in Barron's

From where I sit, there are 2 aspects of this comment that investors may want to consider.

First, it substantiates what I've been saying for several weeks: The message of the market is substantially higher earnings over the next 12 months. Only much higher earnings -- or a P/E that's well above average -- could justify the S&P 500 trading in the 900-plus range.

To refresh your memory, since stocks discount the future, the S&P 500 at 910 is saying that, one year from today, the index will be trading at or above 1000. I provided the math for this in last week's post; at that time the S&P 500 was trading around 940, which produced a 1050 forward-looking number.

Interestingly, if you take a look at Ms. Cohen's comments, the top-end number Goldman forecasts is 1050. And check out the top-end earnings number for the S&P 500: $71. The earnings number I said the market was projecting in last week's article? $70. Close enough.
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