With the market testing its recent lows, I thought it would be a good exercise to come up with a logical downside target for the S&P 500 under a few different scenarios. Of course, it is impossible to pinpoint the bottom, but there is value in taking an educated guess as to what the downside might be.
First of all, let me start out by saying that I think the current estimate of $104 in earnings for the S&P 500 is too high for next year. Analysts tend to be optimistic when forecasting earnings, and cut when companies start falling short. For that reason, I think this is an extremely crucial earnings season to see how companies guide for the future.
900
Let’s say pessimistically that the S&P 500 earns $90 per share next year. At a current level of about 1110, that works out to a P/E ratio of 12.33x, which is still not too expensive. However, the bears will contend that in such a period of uncertainty, investors will not be willing to pay that much for each dollar of earnings. I doubt that the P/E will drop below 10x, so that would give us a target of 900 ($90 x 10). This is the level I have targeted in my head for a while now.
The 900 level is still well below the current price, so that suggests further selling pressure is likely. If the world economy plunges into some sort of mega-recession or depression, than clearly all bets are off, but I don’t see this ultra-bearish scenario as likely. I think a recession is quite possible, which would chop earnings estimates into the $85-$90 level for the S&P 500. The market seems to be pricing some of this in as we speak.
I will start to get very interested in stocks as the 1000 level is breached and will be buying heavily once 900 is approached. Even if it ends up being a bit worse than that, those prices will look great a few years out.
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