The battered S&P 500 index is not pricing in a recession, according to DataTrek Research.
“At 4,000, the recession odds imbedded in S&P are close to zero,” said DataTrek co-founder Nicholas Colas in a note emailed Tuesday. “By our math, 50: 50 odds of a recession equate to an S&P at 3,525.”
The S&P 500
a stock benchmark measuring the performance of large U.S. companies, has dropped more than 16% this year after closing Monday at 3,991.24. That marked its lowest closing value since March 31, 2021, which was the last time the index ended below 4,000, according to Dow Jones Market Data.
The U.S. stock market has tumbled this year amid fears over high inflation, rising interest rates, the Russia-Ukraine war, China’s COVID-19 lockdowns and a slowing economy. “If we do actually get a typical economic downturn, then the S&P should trade for right around 3,000,” according to Colas. Recent volatility simply means that investors believe the window to get back on track is closing,” Colas said. But the window “is not shut yet,” Colas wrote, “otherwise, the S&P would be at 3,500 (50: 50 recession odds) or even lower.”
DataTrek looked at the current “earnings power” of the S&P 500, pegging it at $218 per share. According to the note, this would be “peak earnings” in the event of a U.S. recession. Recessions can have a devastating effect on earnings. However, the effects are different for each country,” stated Colas.
While “standard recessions” cause an average 26% drop in peak-to-trough earnings, the S&P 500 saw a peak-to-trough earnings decline of 57% during the “Great Recession” ending in 2009, according to the note.
So a “garden variety economic contraction” would put S&P 500 earnings at $161 a share, or a 26% drop from the current $218 a share, DataTrek calculated. A 50% chance of recession translates into $190 per share, the note shows.
DataTrek looked at the troughs of price-to-earnings ratios around the past three recessions, estimating an average multiple of 18.5 based on troughs in 2020, 2009 and 2002. Colas tossed out the recession-related trough seen in 1990 as “market valuations were generally much lower than now due to higher interest rates.”
With recession odds 100% baked in at $161 a share, the S&P 500 would be trading at a price-to-earnings ratio of 24.8, according to DataTrek. That compares with a multiple of 18.3 based on $218 per share and no chance of recession, and a ratio of 21.1 at $190 a share and a 50 percent chance of an economic contraction.
So the S&P 500 “needs to go to 3,525,” based on the average 18.5 multiple seen in prior economic downturn troughs, “just to discount 50: 50 odds of a recession,” the note shows. The S&P 500 would trade around 3,000 in a typical recession based on that same multiple and earnings at $161 a share.
” This is not a prediction but a crude, historically supported approach to estimating where the S&P “should” trade if there are more recession fears. DataTrek.