Mister Market is a renowned character created by legendary value investor Benjamin Graham to embody the often erratic, irrational, and unhinged behavior of the overall stock market. Graham and his disciple, Warren Buffett, relished invoking how Mister Market careens from crazy infatuation that make equities incredibly overpriced to senseless dread that yields bargains to be pounced upon. Between the passions and tantrums, they allowed, Mister Market could show good judgment.

Of course, the way Mister Market values stocks mostly reflects his view of where earnings are headed. Over the past seven weeks, the coronavirus crisis has sent Mister Market lurching through his most extreme mood swings in his recent history, tracing his wildly shifting prognosis for profits.

Here’s what investors want to know. Is the level of earnings we’ll see coming out of the coronavirus downturn the number Mister Market embraced when he was throwing a fit, or the much higher benchmark he’s been touting since his outlook suddenly turned sunnier? Once we judge which of Mister Market’s far-apart mindsets make the most sense on earnings, we can establish a reasonable valuation for the stocks.

We’ll use the S&P 500 as our proxy for Mister Market. When the S&P hit its all-time high of 3386 on February 19, earnings-per-share, based on four quarters of trailing reported profits, stood at $139.47. Mister Market was jaunty, unreasonably so. The PE ratio was 24.3, 22% higher than the quarter century average of around 20, and earnings were both at historic peak, and near bubble based their super-high share of revenue. Spooked by the coronavirus outbreak, Mister Market sent the S&P reeling to 2237 on March 23, a rout of 33.9%. At that point, what was Mister Market’s outlook on profits, and was he right?

The premium multiple that Mister Market bestowed in mid-February showed serene contentment. The outbreak has made Mister Market less confident about the future. To express that new anxiety, he’s applying a lower PE, the norm over recent decades of roughly 20. In that case, at the lows on March 23, Mister Market saw S&P 500 profits stabilizing at $111.18.

After the March 23 bottom, Mister Market shook off his funk, and turned positively euphoric. By the close on April 9, the S&P had recouped half its losses, surging 557 points to 2794, a gain of 25% that ranks as one of the half-dozen largest three-week jumps in history.

Naturally, Mister Market suddenly had turned from despondent to feeling his beans about profits. At our PE of 20, the S&P at 2794 would be earnings $139.70 a share. Take a breath, Mister Market! That’s almost identical to the $139.47 stocks garnered at their heights early this year. That’s a fantasy that even the Wall Street fantasists aren’t selling.

Conclusion: Mister Market may be off his meds. The $111 number when the market hit the lows looks pretty reasonable. It’s similar to the level for economist Robert Shiller’s Cyclically Adjusted Price-Earnings ratio, or CAPE, that smooths the erratic swings in profits by using a ten-year average––in other words, casting Mister Market as an even-tempered gentleman.

Mister Market’s swings from low to high spirits on earnings tells us that stock prices were more fairly valued at the depths of 2237 than today’s 2794. In a poll conducted by Refinitiv, Wall Street analysts forecast a 19.4% drop in Q2 profits versus the same quarter last year. But profits will bounce back, whether the rebound begins in late this year or 2021. What’s important for stocks isn’t how they jump around, but where they settle when the comeback begins.

Starting at $111, one-fifth off the old highs, is a pretty good estimate. But it’s a sobering number. Assuming that the S&P continues to distribute 60% of its profits in dividends and buybacks, and reinvest 40% to grow the business, EPS would rise around 5% a year from that base of $111. From there, it would take four-and-a-half years to rescale the the old pinnacle of $140 per share.

At the point where he plumbed the deep valley in late March, Mister Market was looking sensible. He just didn’t know it.

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