How low could the S&P 500 fall before the bear market ends: David Rosenberg

Use this period of strength in the stock market to make a profit and raise cash

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By David Rosenberg and Brendan Livingstone

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One of our key themes this year has been that earnings estimates were wildly optimistic. Analysts are now beginning to accept this view, with 2023 S&P 500 earnings per share (EPS) trimmed to $237 from a high of $249. However, if a recession hits next year (our base case ), there is still a lot to be done in terms of the stock market pricing in a realistic earnings profile.

In fact, based on the historical track record of revisions in recession years, we may ultimately see 2023 earnings end at $177 per share (25% below current expectations). Assuming an unchanged price-earnings multiple, this points to the S&P 500 falling to 3,000 before the bear market is complete. But there is the possibility of an additional disadvantage from this level. A “normal” recessionary low multiple is about 14x, which would put the S&P 500 at 2,500.

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Around recessions, analysts take a long time to adjust their earnings estimates. This not only leads to a false sense of security, in the belief that the impact on earnings will not be as severe, but also makes valuations appear more attractive than they actually are.

For example, the S&P 500 is currently trading at 16.8 times next year’s earnings, but what if this estimate is 10 or 20 percent too high? Well, then we are talking about a “true” multiple of 18.7x and 21x, respectively. No one would be talking about the market being fairly valued at these P/E ratios, especially given the current level of interest rates.

We examine the evolution of earnings reviews during previous recessionary periods

With that in mind, we examine the evolution of earnings revisions during previous recessionary periods. Our data set starts in 1990, giving us four recessions to work with: 1990-1991, 2001, 2007-2009, and 2020. Each year of estimates has 24 months of revision data, from January of the previous year to December of the year. in question. We then plotted the evolution of the 2023 estimate against the average path during recessions and found that it closely tracks the average revision during recession periods.

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From our point of view, there are a couple of key takeaways from this similarity. First, even though the trend has turned negative, the pace of the downgrades really starts to pick up over the next six to 12 months. Put another way, investors should be prepared for EPS cuts to regain momentum in the coming quarters.

Second, if the evolution of the 2023 earnings estimate continues to follow the average trajectory during recessions, this implies an EPS level of $177 per share for December next year. For context, this is 25 percent below what is currently trading, which represents a significant downside risk to the built-in estimates.

If this eventually plays out, we have little doubt that the stock market would succumb to lower lows. After all, even under the (optimistic) assumption of unchanged P/E, a 25 percent hit to earnings would imply an S&P 500 level of about 3,000. If instead we use the trailing 14x P/E multiple that typically marks bear market lows, we could ultimately be talking about the S&P 500 hitting 2,500 when all is said and done.

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Bottom line: the all-time record during recessions shows we could be in the early stages of a period of negative earnings revisions; In baseball lingo, we’re talking about the third inning. As a result, we believe the bear market has yet to move forward, both in terms of duration and magnitude, with a final low for the S&P 500 between 2,500 and 3,000.

Although the stock market will bottom out before the bottom in gains (based on what has happened consistently historically), a more realistic path to gains will still need to be priced in before the bear market comes to a conclusion.

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With this in mind, we would use the recent period of strength in the stock market to take profit and raise cash. We expect better buying opportunities to emerge in the future when a recession is fully “in the price.”

David Rosenberg is founder of the independent research firm Rosenberg Research & Associates Inc. Brendan Livingstone is a senior market strategist there. You can sign up for a one-month free trial at Rosenberg’s website.


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