There is substantial debate on the projected ending value of the S&P 500 Index for this calendar year, to calculate the possible gains to be made by investing in it. It is a work in progress as the year progresses.The S&P Index climbed 4.3 percent during first quarter of the year, after a deep retracement in mid-March. The index closed the quarter at 1,326 after starting the year at 1,271. Consensus estimates for end-of-year S&P 500 index range from 1,375 to 1,400. Projections that consider the low interest rate environment suggest that the value may be higher.Such projections are based on estimated corporate earnings and the amount investors are willing to pay per unit of earnings. The latter is known as the P/E ratio. In round numbers, 2010 corporate earnings were in the area of $73 a share, based on fourth-quarter estimates. This year, the estimate for all the companies in the S&P500 index is $93 per share, according to a Bloomberg survey. That would be a gain of 27 percent. Note that these are only estimates.There is not necessarily a one-to-one relationship in growth in the value of the index versus the growth in earnings. Further interpretation in required, such as the price to be paid for a share in those earnings as compared to other investment options. The P/E ratio represents the dollar paid for a unit of earnings. The market P/E is not static. It has ranged from under 10 to over 30. Currently, it is in the area of 13.7 times earnings. There is much discussion on what the appropriate P/E should be based on a number of metrics.The level of prevailing interest rates has a significant impact on the P/E ratio. Currently, interest rates are near historically low rates. There is an argument that the P/E ratios should be higher in periods of low rates, in the range of 15-22 times earnings. That would equate to a top-range value of 2,046 for the S&P Index. That would be a whopping 60 percent increase from where it was at the beginning of the year. The sustainability of earnings is a large part of the support for a higher P/E. There is still a level of uncertainty on whether the Leading Economic Indicators are on solid ground.Winner of the ‘Charles H. Dow Award’ is Wayne Whaley a commodity trader with Witter & Lester. He has analysed the relationship between P/E ratios and interest rates from 1970-2010. He segmented P/E ratios into periods of Low Rates of less than 5%, Mid-Rates, and High Rates of over 7.5 percent based on an average of 3-mos T-bills, 5-year Notes, and 30-year Bonds. The median P/E for the Low Rate Period was 22.49 times. His band of P/E for periods of Low Rates spanned from 15 to 22.5 times. At 15 times, the S&P would be valued at 1,395, a modest rise from its current level.Another important metric in analyzing the value of the stock market is an Earnings Yield. It is the reciprocal of the P/E ratio. So, if the current P/E is priced at 13.7 times, the Earnings Yield would be 7.3 percent (1/13.7). The Earnings Yield is compared to prevailing interest rates. The spread between Earnings Yield and bond yields are close to historic highs at five points. That is a compelling argument for investing in stocks over bonds. According to Whaley, it supports the case for higher P/E ratios. Stocks would be considered undervalued because rates are low hence the price to buy them should be bid-up.However, the ‘Equity Risk Premium’ for buying stocks instead of bonds should be considered when looking at this spread between the Earnings Yield and interest rates. This Premium is a function of volatility, amongst other variables. Historically, it has been in the range of 4.5 percent to five percent. If the risk-free rate is now in the area of 2.3 percent according to the Barclays Composite Treasury Index, add the risk premium and it adds up to 6.8 percent to 7.3 percent. Not far off the Earnings Yield with the P/E at 13.7.The rate of inflation also impacts the appropriate P/E ratio. Lower inflation rates lead to higher P/E ratios. This is due to the erosive effect of inflation. A real unit of earnings in the future would be of lower in value if inflation is higher. The current rate of inflation is lower than trend, which would support a higher than trend P/E ratio for valuing the market.Testing whether the P/E level is appropriate should also include the projected rate of growth in the earnings. A higher level of growth supports a higher P/E. The PEG ratio captures this relationship. The PEG ratio is the P/E divided by the growth rate. So with the P/E at 13.7 and the S&P earnings growth rate for 2011 is projected in the area of 27 percent, the PEG ratio would be 1.97 times. PEGs over of one (PEG1) indicate that the index is undervalued at the current earnings estimate. The estimate could be off, which would impact the P/E, but indicators are the S&P 500 Index may be undervalued.Projecting the correct level of 2011 earnings for the S&P is dynamic process. This article has focused on projecting the value of the market using various metrics with the estimate of corporate earnings as an input. The calculation of the earnings itself start with the macro-economic back-drop. Indicators are generally positive at this point in time. The US employment number has tipped to 8.8 percent and jobless claims were slightly less than expected. And the US consumer confidence rose again, the first time in a month.While the ISM business barometer fell from the February reading, that was the highest since 1998. Inflation is possible with fuel prices and other commodities rising, but it is nowhere near disconcerting. The President of the Federal Reserve Bank in Minnesota said Thursday that a lift in rates may be in order. There are other hints that the Fed may be acting to raise rates. They are selling $142 million in mortgage-back securities from their portfolio and initiating reverse-repurchase agreements or repos. These are methods for absorbing cash from the monetary system in an effort to increase market interest rates. If this is the case, the economic climate may be improving and corporate earnings on more solid ground. That could support higher stock market values, but only time will tell.Patrice Horner holds an MBA in Finance, a FINRA Series 7 License, and is a Certified Financial Planner (CFP-US). Any opinions expressed in this article are not specific recommendations, nor endorsements of any products. Individuals should consult with their banker, insurance agent, lawyer, accountant, or a financial planner for advice to address their personal situations.