If history is a guide, the S&P 500 stock index may have another 8% to 20% to fall from the current level in the event of a recession, according to an equity research report issued Monday by Standard & Poor’s. Depending on the severity of a potential recession, the report by S&P’s chief investment strategist Sam Stovall sees the firm’s flagship index bottoming at somewhere between 900 and 1030.
Markets have swung wildly in recent days, with widely followed commentators such as DoubleLine’s Jeffrey Gundlach seeing parallels to the crisis of 2008 that sent markets diving. The lesson of 2008, according to S&P’s Stovall (left), is: “Be proactive and expect the worst.” In order to arrive at estimates of what the worst might look like, Stovall crunched the numbers for recessions since 1948 and found that earnings per share on average declined 15% to 20% and that trailing P/E ratios fell to 12 or 13 during market sell-offs.
If there is a second recession now and all specified conditions are met (e.g., declining EPS and P/E), the implied S&P level of 900 to 1030 is close to matching the 960 to 1070 level measured by the average of S&P 500 price declines during post-1948 recessions—a second metric by which to estimate price levels.
The S&P analyst used a third method of analysis to derive a possible floor for the index, which, again, yielded results closely matching the other two analyses. According to this regression analysis, were the S&P 500 index to fall two standard deviations below the mean in “log-scale growth” since its 1932 low (as occurred in the market’s recent 2009 low), the index this time would fall in the 900 to 1000 range. Stovall concludes: “In other words, the S&P 500 would not have to challenge the March 9, 2009 low of 676 in order to register an extreme level of selling and offer a great buying opportunity.”
The S&P 500 closed Monday at 1,124, which is already considerably lower than the average year-end price targets in Bloomberg’s survey of Wall Street strategists. In a post last Wednesday, Bespoke Investment Group put the average year-end price target at 1,383; the lowest target of the group is the Bank of Montreal’s 1,220, more than 8% higher than current prices, indicating that last week’s plunging markets got quite a bit ahead of market strategists, who often revise their estimates throughout the year.
A survey of economists by USA Today taken in the week of Aug. 3-11, before the market made such a hard downward turn, gave just a 1 in 3 chance of a recession. President Barack Obama told CBS News last week he thought a recession unlikely. Economist Nouriel Roubini, nicknamed Dr. Doom, is among those calling a recession likely. He has advised his clients to avoid risky assets and go to cash.