The future could get a lot tougher for investors if a recession strikes the broader economy, according to DataTrek Research co-founder Nicholas Colas.
That’s because even after the S&P 500’s plunge of as much as 28% this year, investors have yet to price in the potential for a significant plummet in corporate earnings. And applying typical valuation multiples seen during recessions would bring down the S&P 500 by 29% from current levels, he estimated.
“It takes a lot of bad news to push S&P 500 multiples down to 15x, but this has happened 3 times in the last decade,” Colas said, pointing to the Greek debt crisis in 2012, the Fed tightening tantrum in the fourth quarter of 2018, and the early stages of the pandemic crisis that saw the market hit lows in March 2020.
On top of the valuation plunge, corporate earnings have plummeted at least 20% during all recessions since 1980.
With the S&P 500 on track to earn about $220 per share this year, a 20% decline would put annual S&P 500 earnings per share at about $176. And applying a 15x price-to-earnings ratio on that amount of earnings generates a price target of 2,640.
