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Jim Cramer: 5 things that must happen for stocks to sustain current levels

CNBC's Jim Cramer laid out a roadmap Tuesday for investors worried about the stock market's valuation as earnings season gets underway.

CNBC’s Jim Cramer laid out a roadmap Tuesday for investors worried about the stock market’s valuation as earnings season gets underway.

The “Mad Money” host said there are five main areas on which to focus in order to determine whether the market is overvalued.

The S&P 500 is currently trading around 22 times earnings, and “historically that’s pretty expensive,” Cramer said.

The current situation is reminiscent of the major sell off that came prior to the 2018 Super Bowl, Cramer said, when money managers sold off S&P 500 futures in response to fears of rising inflation.

Here’s the five things Cramer said need to happen in order for the market to make it “through earnings season unscathed.”

Surpass expectations

The major banks signaled the start to earnings season last week, and their reports came in better than expected, Cramer said. The strong showing will need to be replicated across other sectors, he argued.

J.P. Morgan Chase, for example, reported quarterly earnings that “made its stock look too cheap at 13 times earnings,” he said.

It didn’t rocket shares higher nor did they fall.

“It simply didn’t go down, giving the stock a lower multiple on a higher earnings model,” Cramer explained. “Now it sells for 12 times earnings.”

Goldman Sachs and Morgan Stanley did not disappoint either. The former delivered a consistent number “when we expected inconsistency,” Cramer said, while the latter still sells at the same multiple of 10 times earnings despite a “truly colossal quarter.”

“Usually, these kind of results would trigger terrific rallies, but this is what happens in an expensive market,” Cramer said.

M&A

The market reaction to the flurry of mergers and acquisitions in the fall were an indicator that stocks weren’t as expensive as people worried, Cramer said in November.

That was after the news that Charles Schwab planned to buy TD Ameritrade and LVMH made a deal for Tiffany.

While a similar level of M&A activity hasn’t materialized so far in 2020, Cramer said it remains an indicator of which to be mindful.

“If we see companies buying other companies, that’s a sure sign that these valuations are actually legitimate, that we aren’t paying too much,” he said.

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