On Feb. 26th, I published my ‘revised’ downside for the S&P 500 of 17%. Well, watching CNBC I discover major indexes are now down 17%. I am patting myself on the back, but am hardly ecstatic. So is it all over? My estimate is based on the tried and true back-of-the-envelope approach that has served me well for decades.
The previous estimate (which has proven again most reliable) was simply a P/E multiple for the S&P 500 of 20X zero growth in 2020 of earnings. Well, it looks like zero may prove optimistic. But rather than adjust the earnings (a tough one) it is far easier to simply adjust the P/E ratio. Given that I’ve already described the current situation as a market meltdown (rather than a correction) I believe a P/E of 15X (the historical average for the index) is not an outrageous assumption at all.
Unfortunately, (or fortunately if you’re in cash) that suggests the downside of the S&P 500 is more like 2475 ($165 estimated index earnings for 2019 but with no growth in 2020 times 15). Sounds extreme, but in reality we’ll be lucky if the negative earnings reports we’ll experience over the next 2 quarters can be fully recovered in the 3rd and 4th quarters.
I mentioned in my re-post that ‘relief rallies’ will be commonplace (also called dead-cat-bounces) over the coming weeks and months. This is great news for the savvy traders, but not so good news for the investor who was blinded by the carnage and hung in there. Many investors I’m in touch with insist that everyone is overreacting to the novel coronavirus, and I’d be inclined to agree. However, there are real economic consequences as a result of the overreaction that will impose serious impediments to widespread corporate profitability and economic growth. I used the following example in an article I recently published on seekingalphs.com:
Imagine a town and the only employer assembles vehicles. All of a sudden, the plant cannot get brake pads, and cannot complete vehicles. Similar circumstances are occurring in other towns with other businesses. Firms are reluctant to fire people, since they know the supply disruption will ease eventually. However, they have to lay off people for an unknown time; those folks don’t go to their favorite coffee shops, don’t buy items they normally would (and aren’t available anyway due to supply interruptions) and so on. Despite the slowdown in economic activity, prices are rising due to shortages. Sounds like the Russian economy at the height of its doldrums? Except this is occurring on a global scale.