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My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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How Much Worse Could this Get?

Updated: Jul 19, 2020

How much worse could the stock market get? When I saw Goldman Sachs say that the S&P 500 could go as low as 2,000 in a Bloomberg article on Sunday, I didn’t really want to believe that figure given that the index closed Friday at 2,711.02 after an excellent finish to the day. However, in spite of a massive dose of monetary stimulus announced by the Fed on Sunday evening, the market completely tanked yesterday, closing down nearly 12% at 2,386.13. At this pace, it won’t take many more days for the S&P 500 get reach 2,000. But does this level have any rational basis?

To provide some perspective, the S&P 500 reached a record high on February 19th, 2020 of 3,386.15. The index increased 62% in the five years between 2015 and 2019. However, at yesterday’s close, we are down 42% from the highs reached less than one month ago. This is a dramatic decline triggered by the “great unknown” of uncertainty associated with the length and depth of the economic damage that is being inflicted by the COVID-19 pandemic. It is also important to remember though that valuations were high to start with, as the S&P 500 seemed to reach record highs time and time again during the latter half of 2019 and into early 2020. As the level of the S&P 500 crept up, the P/E ratio was also nearing cyclical highs as far as recent (pre-recession) levels. You can see the P/E ratio for the last 50 years below (source: (Note that the extreme peaks in this graph have generally come during the late stages of recessions when equity markets were recovering as the economy stabilised, but earnings were trailing the recovery.)

Although valuations were certainly approaching the high side (the P/E ratio was flirting with 25x at year-end), the real issue is of course the ongoing effects of COVID-19 on the global economy as the world shuts down, which will cascade into corporate earnings. The economic effects will undoubtedly be dire in the near term, but the hope is that the trajectory of growth of COVID-19 will slow now that (finally) most countries have started to take this pandemic serious and warmer weather is on the horizon in the Northern hemisphere. Should things unfold this way, the hiatus will hopefully allow time for pharmaceutical companies to develop vaccines so that the growth of the virus does not re-start in the autumn.

I included my outlook for S&P 500 earnings yesterday in my weekly update, which is at best an educated “guestimate” based on the assumptions I mentioned in the paragraph above regarding COVID-19 and the performance of corporate earnings in prior downturns. Before I present my findings, I want to point out that – in my opinion - value will be evident first in individual stocks not in the indices (like the S&P 500). The reason is that equity indices are generally market-weighted by company, and as index funds unwind or rebalance their portfolios to address selling pressures and redemptions, “good” stocks will get sold alongside the “bad”. Attractive valuations in individual shares will inevitably surface. Of course the earnings of companies in some sectors will be much more negatively affected by the Coronavirus-led economic downturn (not to mention the dramatic reduction in oil prices). With that in mind and to get you thinking, below is the sector-weighting of the S&P 500 at mid-year 2019.

To provide further context regarding the pie chart above, the most troubled sectors currently are energy (5.1%); industrials (9.4%) which includes cyclical industries, airlines and transportation; consumer discretionary (10.2%) which includes travel, hotels, restaurants and leisure; and increasingly financials (13.1%).

The estimates for 2020 earnings by quarter which I mentioned in the weekly update from on Monday (March 16th) were as follows:

- 1Q: earnings down 1% (vs 1Q2019, the same quarter in the prior year),

- 2Q: earnings down 3-4% (vs 2Q2019),

- 3Q: earnings up 2%-3% (vs 3Q2019),

- 4Q: earnings up 6%-8% (vs 4Q2019).

Looking forward and admittedly even more of a “guestimate”, I have used growth of 6%-8% / quarter (quarter-over-same quarter for the prior year) for the first three quarters of 2021, and 4%-6% for the fourth quarter of 2021. Note that all of the earnings growth figures are quarter versus the same quarter of the prior year, so for example, 1Q2020 earnings of down 1% is compared to 1Q2019 earnings.

The other rather critical number that matters for estimating the floor for the S&P 500 is the P/E ratio for the index. I have chosen to use what I believe are realistic figures over the next eight quarters although the “correct” number is far from certain because dynamics are moving markets in an unusual way at the moment. In an environment overwhelmed by “sell, sell, sell”, investors will be clamouring to get out no matter what the P/E ratio is. This is the exact opposite of irrational exuberance, and it feels increasingly like this is where we are at the moment. Checking the data, the S&P 500 ratio has rarely been below 15x in the last 30 years. It was below 15x in the 2H2011 (bottomed at 13.5x late in Sept/Oct), then for two months in late 1994, and lastly for three months in late 1990. Based on annual S&P data, the median P/E ratios for the last 20, 30 and 40 years have been 21.1x, 21.4x and 19.6x, respectively (source:, and you can find it here). Lastly, there are many more variable than just expected earnings and the P/E ratio that drive stock prices, including variables like interest rates, dividend yields, relative value of other assets, sentiment and so on. As a disclaimer, I have not considered any of these other variables, which research teams at large banks will have considered because they have loads of people and tonnes of data at hand.

Below are earnings, index levels and P/E ratios for the last 20 quarters:

With this background, based on my quarterly earnings assumptions discussed above and the P/E ratios by quarter that I have used in the table below, I believe that the S&P 500 index could fall to as low as 2,030 before recovering. I believe that these lows could be reached between now and mid-April and given the velocity of declines and lack of confidence in the market, it could come sooner rather than later. As a reminder to the reader, the great unknown remains the trajectory of COVID-19, and its path is difficult to project although the hope is that the decline in cases in China and South Korea are the way forward.

A drop in the S&P 500 index to 2,030 would mean that from its peak to its trough, the market would have fallen by circa 40%. This compares to the last two severe downturns in the U.S. equity markets of peak to trough of -57% during the Great Recession of 2007-2009, and -49% during the bust in 2000-2001. You can see other declines during difficult economic periods in this graphic below from CNBC.

The magnitude of such a drop would be somewhat unprecedented, but the severity and swiftness of the decline in the last four weeks has no comparison, as this chart from the FT yesterday illustrates.

I suppose the good news – relatively speaking anyway – is that if I am right on the floor (and I hope I am badly wrong on the side of being too conservative), we could see the S&P 500 end the year back in the neighbourhood of 2,600-2,650, and hopefully reach 3,000 again by the end of 2021. Many pundits are predicting a much faster recovery – a V-shape – once things settle, and I really hope they are right. Lastly, if you invest in stocks, I would encourage you to focus on individual names rather than the indices, because there will inevitably be plenty of value to comb over. There are undoubtedly some very prominent names that are starting to look very cheap at the moment.

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Mar 18, 2020

You are welcome, just wanted you that I was reading.

Mar 17, 2020

Thanks, my bad. Decline on apples-to-apples basis peak-to-trough would be circa 40%. Edited accordingly.


Mar 17, 2020

Third paragraph from the end, first sentence - The S&P has not fallen by 67%, but to 67% of its highest value. Please correct.

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