My original estimate (February 3rd) was simply a P/E multiple for the S&P 500 of 20X zero growth in 2020 of earnings. I expected the coronavirus to have a devastating impact on the global economy (oil prices, supply chains etc.) but WOW, it has certainly escalated quickly. Well, it now seems like zero earnings for 2020 may prove optimistic.
The S&P 500 dived past my initial target of 2600, and looks like it might break through my second more pessimistic target (Feb. 26). Rather than adjust the earnings (a tough one) I simply adjusted the P/E ratio. I’ll quote myself:
“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…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.”
Revisions to company earnings are going to be scathing. Analysts tend to overshoot when optimistic, and initially are reluctant to revise downward when things look grim – but revise downward they will in time, and with gusto. If we expect 10% lower corporate earnings for this year (and estimates may be even worse when capitulation truly sets in) then the downside risk to the S&P 500 is closer to 2200. This would imply a decline of about 35% from the high.
It might even get worse in terms of expected earnings depending upon how badly the panic affects real economic activity, which in turn will bias sentiment negatively. However, if (or when) we do get down there, and market pundits quit saying: “This too shall pass.” then it will be wise to start buying like there’s no tomorrow. You won’t want to, but you probably should. Indeed this will pass, but it isn’t until nobody believes it will pass that it will indeed pass.