NEW YORK (
TheStreet) -- Have a look at what has become my favorite chart for the new year of 2012, the reason I am very bullish on stocks for the coming year. It shows a traditional measure of how earnings describe the value of the stock market, in a clear and simple way, using the
Let me quickly explain this chart and why it points to higher stock prices.
When determining a stock's value, we know that earnings are one of the most important metrics to consider, but not the only one. Along with how much a company makes, we also know that the stock market puts a specific value on each company's earning potential by attaching a multiple to those earnings as well. By understanding earnings and multiples, you can finally begin to understand a stock's price.
But when taking the entire 500 stocks that make up the index as a whole, the multiple that is being applied as an average to all becomes less variable, although critical to assessing prices. For the purpose of understanding my favorite chart, it is enough to know that most analysts are comfortable saying there won't be a huge compression (or expansion) of multiples in 2012.OK, then. With multiples that remain relatively static, we are left with a chart above that we can see has tracked pretty closely the price of stocks in the S&P 500 and the underlying earnings for the S&P, and we can readily see how closely the two are correlated. Very closely, that is, until the middle of 2011, when the combined effects of the Japanese earthquake, Greek debt and Euro credit crises pummeled shares, chasing investors out of stocks and sending share prices swooning. During that summer and following fall of 2011, the "word" was all about an impending "double dip" recession here in the U.S. and the exploding of the European Union. But while outflows from equity funds increased and the world worried about a nuclear disaster at Fukushima and another "meltdown" of EU sovereign debt, earnings in the U.S. continued to report well -- and continued to rise. We'll find out where those earnings for the S&P 500 will factually come in for all of 2011 as the earnings reports for the fourth quarter now begin to come in. It would be hard to imagine enormous disappointments, as earnings are expected to show more than $95 a share for 2011.