How the Pros Call The Bottom

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How the Pros Call The Bottom

You have probably seen and/or heard dozens of market commentators discuss their views on where the S&P 500 bottoms in the current market cycle.  Some say we are at the lows right now.  Others think the index might make its lows at 3,400 or 3,000 or even lower still.

This is an important debate for every investor, even those who do not own US stocks.  History repeatedly shows that stressed global equity markets all bottom at roughly the same time.  Call the bottom on the S&P and you have likely called the lows for non-US equities as well. 

We use two approaches when considering where the S&P may make its final low.

The first is to examine past index prices.  We can look back at history and say on X date the S&P traded for Y.  Since we know what the index was earning as of that date, we can also back into a valuation and consider how current market conditions compare to those precedents.  For example:

  • S&P at 3,386, about 7 percent below recent levels.  This was the last new S&P 500 high before the Pandemic Crisis hit, set on February 19th, 2020. The S&P had earned $163/share the prior year, so the index was trading for 21x trailing earnings.
  • S&P at 2,977, about 18 percent below recent levels.  This is where the S&P closed at the end of Q3 2019, just before it rallied 14 percent to the February 2020 highs.  The PE here is 18x, based on the same $163/share noted above. 

Round those to 3,000 – 3,400, and you get a reasonable S&P 500 price target based on the simple assumption that the index must give up all its Pandemic Era gains before it can make a bottom.  If we assume the S&P will earn $176/share in a recessionary 2023 (20 percent below current earnings of $220/share), we get an implied PE ratio of 17 – 19x.  In such an environment, interest rates should be lower than today, so those multiples seem fair enough to us. 

The second approach looks at expected future S&P 500 earnings per share and pairs that analysis with what investors might be willing to pay for those results.  From 2013 to 2019, the S&P traded for 15 – 19x forward earnings.  Investor sentiment determined where stocks traded on that spectrum. In the early part of that period, not long after the Financial and Greek Debt Crises, they were at the low end of that band.  As the US economy continued to grow and earnings improved, PEs eventually reached 19x in 2019.

Applying that same 15 – 19x band to a range of potential future S&P earnings gives us the following price targets:

S&P earnings of $220/share (current run rate, no recession):

  • 15x (low investor confidence): 3,300
  • 17x (medium investor confidence): 3,740
  • 19x (high investor confidence): 4,180

S&P earnings of $198/share (10 percent below current earnings, slight recession):

  • 15x (low confidence): 2,970
  • 17x (medium confidence): 3,366
  • 19x (high confidence): 3,762

S&P earnings of $176/share (20 percent below current earnings, full recession):

  • 15x (low confidence): 2,640
  • 17x (medium confidence): 2,992
  • 19x (high confidence): 3,344

The range here is broader than the first approach, yielding results from 2,640 (28 percent below current levels) to 4,180 (14 pct above current levels).   At the low end, a recession hits earnings with full force and investors lose all hope in an eventual recovery. At the high end, earnings remain robust, and investors continue to keep the faith.  At present, the S&P 500 reflects the middle scenario (a slight recession) and medium – high confidence (17x – 19x PE). 

Takeaway: as poorly as the S&P has performed YTD, investors continue to price stocks as if a severe recession is unlikely and market sentiment will remain reasonably strong.  If your perspective is different from that still-upbeat take, the tools and approach we have described here give you all you need to determine where US large caps will eventually bottom.