The index blew through my original target (from early February) of 2600 – which I determined prior to the global lock-down meant to contain the novel coronavirus. It was based on an average P/E of 15 times no growth in earnings this year. People responded angrily at the lower (than 20X) multiple because of low interest rates, and generally thought the target impossible. Here’s a quote from more recent (March 16) article where I revised down based on deteriorating expectations for corporate profitability.
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 2,250 – the long-term average P/E times roughly $150 earnings for the index. This would imply a decline of about 35% from the market high.
On Monday March 23rd, the S&P 500 closed below the revised target at 2,237.40 . Trust me, this doesn’t make me want to gloat.
Clearly, based on press coverage alone now capitulation has indeed set in. I can’t count how many times in the past (articles, TV and radio interviews) I’ve said markets overshoot on the upside (which was why I was bearish in the first place) as well as the downside. I wouldn’t be shocked (surprised maybe) if the investing hoard soon comes to believe that corporations will suffer several months of no earnings this year. Earnings aren’t linear (seasonality) and summer is ordinarily weak and we’re almost there, but I need to come to grip with some sort of prediction – so I know when to get really aggressive buying.
I’ve already been (as mentioned in other blogs) picking away at some down and out names that have declined 75% to 80%, intending to hold on to them for a few years. Either they recover some or go bankrupt, but I’m betting on the former.
To simplify my life, I’ll presume that last year’s $165 of S&P 500 earnings was linear (absurd but easy) and comprised of $13.75 earnings per month. If investors at large anticipate losing 3 months (hopefully not much more) to industry and trade shutdowns (or the equivalent spread over more months) then earnings corresponding to the S&P 500 would be in the neighborhood of $123.75. At 15X we could see the index at 1856 or thereabouts. This is down another 17% from its current level, or just over 42% from the December 2019 close. We get there and I’ll surely be selling a couple of guitars to buy stocks…any stocks.