Investors haven’t started pricing in a recession yet — That’s how far the S&P 500 could go

The battered S&P 500 Index is not pricing in a recession, according to DataTrek Research.

“At 4,000, the S&P embedded recession chances are close to zero,” DataTrek co-founder Nicholas Colas said in a note emailed Tuesday. “According to our calculations, a 50:50 chance of a recession corresponds to an S&P reading of 3,525.”

The S&P 500 SPX,
a stock 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. That was the lowest close since March 31, 2021, when the index last closed below 4,000, according to Dow Jones Market Data.

The US stock market has plummeted this year on fears of high inflation, rising interest rates, the Russia-Ukraine war, China’s COVID-19 lockdowns and a slowing economy. “If we’re actually seeing a typical economic downturn, the S&P should be trading right around 3,000,” Colas said.

“Recent volatility is simply saying that investors believe the window is closing to get back on track,” he said. But the window “isn’t closed yet,” Colas wrote, “otherwise the S&P would be at 3,500 (50/50 recession chances) or even below.”

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DataTrek looked at the current “earnings power” of the S&P 500 and put it at $218 per share. Those would be “top gains” as the US heads into recession, the release said.

“Recessions have obviously hurt earnings, but to varying degrees,” Colas said.

While “normal recessions” cause an average 26% decline in peak-to-trough earnings, the S&P 500 saw a 57% peak-to-trough earnings decline during the “Great Recession,” which ended in 2009, according to the release. .

So a “garden-like economic contraction” would take S&P 500 earnings to $161 per share, down 26% from the current $218 per share, DataTrek calculated. A 50 percent chance of a recession equates to $190 per share, the note shows.

Read: The Fed can cool inflation this year and economic growth will continue, Williams says

DataTrek examined the bottoms in price-to-earnings ratios around the last three recessions and estimated an average multiple of 18.5 based on the bottoms in 2020, 2009 and 2002. Colas discarded the 1990 recession bottom as “market valuations.” . generally much lower than now due to higher interest rates.”

With recession odds of $161 per share 100% baked in, 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 a recession, and a 21.1 multiple at $190 per share and a 50 percent chance of an economic contraction.

So the S&P 500 “needs to rise to 3,525” based on the 18.5 average multiple seen in previous economic downturns “just to account for the 50/50 probability of a recession,” the note shows. The S&P 500 would trade around 3,000 in a typical recession based on the same multiple and earnings of $161 per share.

“This is not a prediction, but rather a rough but historically sound approach to assessing where the S&P ‘should’ trade if recession fears continue to mount,” DataTrek said.

The US stock market ended Tuesday mixed, with the Dow Jones Industrial Average DJIA,
fell 0.3% to post a fourth straight day of losses. The S&P 500 was up about 0.2% to close at 4,001.05, while the tech-heavy Nasdaq Composite COMP,
1% gained. All three major benchmarks suffered sharp sell-offs on Monday.

Market volatility remained elevated on Tuesday. The CBOE volatility index VIX,
was trading at around 33, according to FactSet data, after closing at around 34.8 on Monday. That’s above the 200-day moving average of 21.9 and the 50-day moving average of 26.5. Investors haven’t started pricing in a recession yet — That’s how far the S&P 500 could go

Brian Lowry

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