I use $70 as my normalized earnings estimate for the S&P 500.  With the market closing at 789, the market is trading at ~11x my normalized earnings estimate. 

Aggregating bottoms-up operating earnings forecasts for 2009, earnings this year are expected to be $62, and the market is trading at 12.7x earnings.  Operating earnings for 2010 are expected to be $78, meaning that the market is trading at 10x estimates.

Financials are currently less than 10% of the market capitalization of the S&P 500.  (Banks, thrifts and zombie financials such as AIG are ~3.5% of the index.)  Let us say that the entire financial industry gets wiped out this year.  If so, stocks are trading at ~14x this year's operating earnings and 12x next year's earnings.

"But earnings estimates are coming down!"  Absolutely true.  We all know the hit earnings took last year.  According to Standard & Poor's, with 85% of companies reporting Q4 profits, reported GAAP earnings for 2008 are expected to be $28.  And GAAP earnings are forecasted to be $32 in 2009.  Off these earnings, the market is expensive, right?  The S&P 500 is trading at 28x and 25x last year's and this year's earnings.

But is the market index the correct measure of the underlying profitability of corporate America?  The steep decline in earnings in 2008 was due primarily to enormous right-offs within the financial sector, which is skewing the profitability of the index averages. 

The market looks much better when looking at the median price/earnings ratio.  The median PE of the S&P 500 as of the close today is 10.6x trailing earnings.  For 2009, it is 11.1x.

Stocks are cheap.

And Jeremy Grantham agrees.