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Tickers in this Article: SPY, IJR, IJH, IWW, IZZ
How much of the decision to sell stocks - indiscriminately - over the last three weeks was rooted in fear, assumptions, and a need to follow the crowd?

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As of the new lows for the year hit on June 30, stocks are arguably on pace to be as cheap as they have been in the last year. Even on a trialing basis though, based on P/E ratios, they're well under long-term average valuations.

Here are the numbers more of us should have been dissecting, rather than hitting the "sell" button early and often. And yes, I know there are underlying reasons for the recent implosion.

Cheap
There's more to valuation than a price-to-earnings ratio, especially a forward-looking one. On the other hand, this "unsophisticated" valuation measure still has practical significance.

As of June 30, with a closing price of 1030.71 for the S&P 500, the index's trailing twelve-month operating P/E ratio stands at 15.6. The forward -looking P/E (which includes Q2-2010) now stands at 12.2. For those of you who know too many details of the market's history, you'll know both figures are stunningly low. We haven't seen a sub-16 P/E since 2006, and that was a rarity. You have to go back to 1995, and then to 1990, to find the only other periods where earnings multiples were that low.

And, it's not just large cap stocks - perhaps proxied by the SPDR S&P 500 Fund (NYSE:SPY) - that have been beaten down to valuations that are strangely low. If you own the iShares S&P 600 Small Cap ETF (NYSE:IJR) or the iShares S&P 400 Mid Cap Index (NYSE:IJH), you're also experiencing the bitter sweetness of falling prices in the face of rising earnings.

The S&P 400's close of 939.88 on Wednesday is only 21.6 times 2010's projected earnings, and only 17.6 times 2011's estimates. For the S&P 600, those respective P/E ratios roll in at 12.9 and 16.5. While those numbers may seem nominal by S&P 500 standards, for small and mid caps, that's pretty low.

The vertical uniformity in low prices can be found horizontally too. As of June 25, the iShares Russell 3000 Value ETF (NYSE:IWW) boasts a P/E (trailing) of 14, while the iShares Russell 3000 Growth Fund (NTYSE:IWZ) sports a P/E of 16.

While I don't have the forward-looking data for the growth and value segments, we can reasonably assume it mirrors the forecasted growth evident in other classifications. So what gives? This is where it gets juicy.

Forget the Past, What about the Future?
You own stocks for where they're going - not for where they've been. In that light, it's clear investors have begun to think much less of companies' futures than they expected just a few weeks ago. As of Wednesday, the correction from the April 23 peak has exceeded the average 13.7% corrective dip - the latest leg of which was spurred by a sudden and surprising dip in consumer confidence, an apparent slowing for China's economy in April, and tepid job growth, according to Wednesday's ADP Employment Report.

Add that to the backdrop of debt trouble in Portugal, Spain, Italy and Greece, and it's no wonder stocks have been bashed of late. There's just one flaw in the logic: the bulk of those problems are either (1) overblown, (2) reeled in to manageable levels or (3) don't affect earnings of a significant number of (if any) U.S. stocks.

Although we live in a globalized economy, the relationship that many U.S. companies have with international markets seems overblown based on actual operational and balance sheet exposure. I feel Standard & Poor's is being a tad too enthusiastic with its 2010/2011 earnings outlooks, stating that earnings will rise by 34% in the upcoming quarter.

On the other hand, even if Greece defaults, given that its economy is about half the size of Connecticut's, it won't even be a blip for the global economy. No job growth? No argument - but it hasn't stopped four quarters' worth of earnings growth. China slowing down? It was one month's worth of data and it was April's data at that. Sorry, but none of these or any of the others are really great reasons to dump stocks first, and ask questions later.

The Bottom Line
The result of the knee-jerk reaction is a market that's now at the low-end of its long-term valuation range and no real reason to expect earnings to shrivel for the next year and a half. Indeed, Q2's corporate earnings are still expected to have grown 34.3% on a year-over-year basis, while sales are forecasted to be higher by 9.4%. My biggest fear now isn't a collapse of the eurozone, but that the market will ignore earnings results. (Internal return on investment helps determine a stock's ability to propel shareholder returns. To learn more, read Earnings Power Drives Stocks.)

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