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S&P 500 could fall another 26 percent
Colas: Current price levels do not yet reflect the risk of a recession
On average, recessions resulted in 26 percent lower corporate profits
The S&P 500, which tracks the performance of the 500 largest US companies, fell as low as 3,858.87 points last Thursday. This corresponds to a loss of 19.91 percent compared to the record high of January 4, 2022 at 4,818.62 points. Most recent falls are attributed to investors’ fears of a global recession caused by a toxic cocktail of inflation, interest rate hikes and supply chain problems. But DataTrek analyst Nicholas Colas warns that a potential recession is not yet priced into stock prices. How far does he see the S&P 500 falling?
Colas: That’s how low the S&P 500 could fall
Colas still sees considerable scope for the US stock exchanges to fall, as he emphasizes to “MarketWatch”. If the current recession probability, which he estimates at 50:50, is correctly priced in, the S&P 500 will fall to 3,525 units – i.e. a further 10.2 percent from the current price level of 3,923.68 points (as of the closing price on May 18, 2022). .
But it could get much worse. Colas explains: Should a typical economic downturn actually occur, the S&P should trade at around 3,000 points. That would mean a 37.4 percent crash from the record level of the broad US index. From the time of the study, when the S&P 500 was trading at around 4,100 points, the decline would be 26 percent.
Current prices do not yet take into account the possibility of a recession
With the index reading around 4,000 points, a recession is not yet priced in: “The recent volatility simply shows that investors believe that the window for a return to the right track is closing,” he said. But the window “isn’t closed yet,” Colas points out, “or the S&P would be at 3,500 (50:50 recession probability) or even lower.” Even if the stock market downturn is very painful for investors, it still does not reflect the more pessimistic future scenarios, warns the market expert.
The math behind Cola’s price targets
Complex mathematical calculations are behind the S&P 500 price targets of 3,525 and 3,000 points, respectively. DataTrek, using recent earnings reports, put the earnings per share of companies included in the S&P 500 at $218. If the US economy should slide into recession, this value would represent the interim record high for corporate profits.
On average, company profits collapsed by 26 percent during the historic recessions, and by a whopping 57 percent during the financial crisis of 2008/2009, “DataTrek” found out. As a result, an “ordinary” economic slowdown would reduce earnings per share in the S&P 500 to $161 – and thus the index’s score to the said 3,000 points.
A 50 percent probability of such a 26 percent drop in profit would thus be achieved with a setback of 13 percent. “DataTrek” comes to the exact value of 3,525 points, ie 13 percent lower than on the day the analysis was published.
A look at stock market history
Colas supports his argument with a look at recent stock market history. In the past three US recessions in 2002, 2009 and 2020, the price-earnings ratio (P/E) was around 18.5 during the stock market low. The current price level of the S&P 500 of around 4,000 points would show a price-to-earnings ratio of 24.8 if a recession actually occurred. A drop to 3,000, on the other hand, would be pretty close to the historical average of 18.5.
By the way: The current P/E of the S&P 500 is just over 18. This is a reasonable valuation – but only assuming there is no recession. At the moment, however, one can no longer rule out such a thing, as Colas emphasizes.
Editorial office finanzen.net
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