[jyl]

SP500 P/E (on 2011E) is 12.3X.

Build yourself a simple DCF model for SP500. Assume earnings = free cash flow, which is a reasonable simplification over time. 10 year yield is 2.2%, use a simple discount rate of 2.2% + equity risk premium. To simplify again, assume earnings growth for the terminal period is zero. So we only have two variables: equity risk premium and earnings growth for the forecast period (10 years).

See what you have to do to those variables to get a 12.3X.

Here is one way to get there: ERP +5% (roughly the historical mean), forecast growth -3%. Another way is forecast growth
+2% and ERP +7.5%. Do those sound reasonable?