According to DataTrek Research, the battered S&P 500 index is priceless in recession.
“At 4,000, the chances of recession embedded in S&P are close to zero,” DataTrek co-founder Nicholas Colas said in an emailed note on Tuesday. “According to our math, the 50:50 probability of a recession is equivalent to an S&P at 3,525.”
The S&P 500 SPX,
a benchmark that measures the performance of large U.S. companies, has fallen more than 16% this year after closing at 3,991.24 on Monday. This marked its lowest closing value since March 31, 2021, which was the last time the index ended below 4,000, according to Dow Jones Market Data.
The US stock market has fallen this year amid fears of high inflation, rising interest rates, the war between Russia and Ukraine, China’s blockades on VOCID-19 and a slowdown in ‘economy. “If we really get a typical economic downturn, then the S&P should trade around 3,000,” according to Colas.
“Recent volatility simply says investors think the window of opportunity to get back on track is closing,” he said. But the window “is not yet closed,” Colas wrote, “otherwise the S&P would be at 3,500 (50:50 odds of recession) or even lower.”
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DataTrek analyzed the current “profit power” of the S&P 500, setting it at $ 218 per share. According to the note, this would be the “maximum profit point” if the US is heading for a recession.
“Recessions affected gains, of course, but in varying amounts,” Colas said.
While “standard recessions” caused an average 26% drop in maximum-to-minimum gains, the S&P 500 saw a drop in peak gains of at least 57% during the “Great Recession” that ended in 2009, according to the note.
Thus, an “economic contraction in garden variety” would place the S&P 500 earnings at $ 161 per share, or a 26% drop from the current $ 218 per share, DataTrek calculated. A 50% chance of recession translates into $ 190 per share, the note shows.
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DataTrek analyzed the lows of price-to-earnings ratios around the last three recessions, estimating an average multiple of 18.5 based on the lows of 2020, 2009 and 2002. Colas released the recession-related low seen in 1990 as “market valuations were generally much lower than now due to higher interest rates.”
With the odds of a 100% recession at $ 161 a share, the S&P 500 would be trading at a price-to-earnings ratio of 24.8, according to DataTrek. This compares to a multiple of 18.3 based on $ 218 per share and no chance of recession, and a ratio of $ 21.1 to $ 190 per share and a 50 percent chance of economic contraction.
Therefore, the S&P 500 “should reach 3,525”, based on the average multiple of 18.5 observed in the previous economic recession lows, “only to discount 50:50 the probabilities of a recession”, shows the note. The S&P 500 would trade around $ 3,000 in a typical recession based on the same multiple and earnings at $ 161 per share.
“This is not a prediction, but a crude but historically defensible approach to assessing where the ‘S&P should’ negotiate ‘if fears of a recession continue to grow,” according to DataTrek.
The US stock market ended mixed on Tuesday, with the Dow Jones Industrial Average DJIA,
falling 0.3% to record a fourth consecutive day of losses. The S&P 500 rose about 0.2% to close at 4,001.05, while the technology-laden Nasdaq Composite COMP
gained 1%. The three main benchmarks had suffered a strong sell-off on Monday.
Market volatility remained high on Tuesday. The CBOE VIX volatility index,
it traded around 33, after closing at around 34.8 on Monday, according to FactSet data. This is above the 200-day moving average of 21.9 and the 50-day moving average of 26.5.