We’re now entering the thick of earnings season again, and obviously things are going to be a little nastier than they were a year ago, or even three months ago. However, the question is whether or not earnings will be better or worse than expected. (Meeting a low expectation can still be a good thing for a stock.) And, the same applies to the overall market….if companies aggregately beat the average expectation, it could be good for the whole market.

With that in mind, here’s some key earnings data for the S&P 500, which is currently priced at 930.99. (By the way, I’ve got forecasted sector P/E’s below…which is actually the whole point of this entry.)

The consensus estimate for forward-looking 52-week operating earnings for the S&P 500 is now $90.65 (P/E = 10.27), which is down from $102 (P/E = 12.1, at the time) a couple of months ago. And, trailing operating earnings are reported to be $61.27 (P/E = 15.2), which is down from $91 this time a year ago (P/E = 16.7, at the time).

I had to read the numbers a couple of times to figure out what I was missing, ’cause they just don’t jive. Then I came to this conclusion - the estimates jive….they’re just still too optimistic.

Basically what Standard and Poor’s is saying is that stocks are undervalued compared to where they were two months ago, AND they’re going to be about 33% more profitable over the next twelve months than they were over the last twelve months. In short, they’re predicting a full recovery back to 2006’s earnings levels (when times were pretty good).

My question is this - what’s going to happen over the next year that will cause earnings to improve from $61.27 to $91.00? I’m not saying it can’t happen…I’m just saying “show me why and how”. After all, they were wrong two months ago about where we’d be now. Why should we trust ‘em about where we’ll be 12 months from now? (That’s a rhetorical question, of course.)

That said, I want to clarify my stance….I’m optimistic too, but only because I know stocks don’t always trade at that they’re worth. I think 2009’s valuations won’t be as attractive as guessed by our friends at S&P because stocks will be priced at what the market thinks they’ll be worth in 2010. That’s why I’m planning on ‘paying up’ a little in 2009 for decent equities…they’ll be moving higher in advance of earnings results. I won’t be worried about doing so either, at least not until I start to see P/E’s (trialing) reach above 17/18-ish.

That’s not exactly what I came here to talk about though. I actually came here to talk about sector valuations, and making meaningful valuation comparisons within a sector. You know - apples to apples.

See, I’ve got a feeling in 2009 we’re going to start seeing some serious sector divergence, which we didn’t see much of in 2008 - all sectors stunk. I’ve got some opinions on which sectors will be hot and cold, but I want to lay this groundwork first because it will be a large part of my selection strategy.

The nearby table lays out Standard & Poor’s forecasted P/E’s for all the major sectors (as of November 4th). My strategy is a simple peer comparison. Basically, if I’m looking for undervalued stocks, the forecasted P/E (or even the trailing P/E) has to be as cheap or cheaper than the respective sector.

Now, do I trust the Standard & Poor’s forecast? The whole point of the rant above was to illustrate how even S&P can be too optimistic for the overall market, so I have no reason to think they’d suddenly be realistic when it comes to sector earnings forecasts. However, as long as they’re consistently overly-optimistic, we can still make useful comparisons.

In short, on a forward-looking (2009) basis it looks like Standard & Poor’s thinks stocks are trading at about 2/3 their historical values. That’s pretty exciting, though perhaps a little too enthusiastic. Still, even if companies fall short of the expectation - and I think they will - I still see some significant value in technology, energy, telecom, and general industries. I have to like financial stocks too, but that’s not really based on valuations….that’s just based on them being so beaten up.

This is just the beginning of creating a sector outlook. Stay tuned as I rationalize my way though a complete sector forecast for 2009, though sector rotation is a journey and not a destination.