The S&P 500 (NYSEARCA:SPY) closed Monday at a 2022 low of 3,655.04, but RBC Capital Markets argues the index could shed another roughly 4% to reach 3,500 – or even 3,050 if equities experience a 1970s-style meltdown.
“We think stocks are on the cusp of an important test,” Lori Calvasina, RBC’s head of U.S. equity strategy, wrote in a note. “If the S&P 500 (SPY) experiences its typical recession drawdown of 27%, the index will fall to 3,501. … A 63% contraction, similar to the 1970s, would take the P/E to 14x, implying a move to 3,052.”
Calvasina analyzed 10-year Treasury yields, the Personal Consumption Expenditures index of inflation (PCE) and other data going back to the 1970s to estimate that the S&P 500’s trailing price-to-earnings ratio will fall to 16.35x from today’s roughly 18x.
She wrote that such a decline would represent a 57% pullback in the S&P 500’s P/E from its 37.8x pandemic-era high – “close to the contraction that was seen in the 1970s and after the (late 1990s/early 2000s) Tech Bubble.”
As RBC currently estimates big-cap companies will earn $218 a share in 2022, a pullback of that size would imply that the S&P 500 falls another 4.2% from here to reach 3,564 by Dec. 31.
Calvasina added that a different analysis points to the S&P 500 (SPY) sinking even further to around 3,501. After all, she wrote that the index historically loses a median 27% in and around recessions dating back to 1937 (excluding the 2001 recession and a 1945 downturn that saw no market pullback). A retrenchment of that size would take the S&P 500 (SPY) down to just above 3,500.
The analyst added that an even more pessimistic forecast could see the S&P 500’s P/E sink 63% – the type of drop recorded between June 1971 and December 1979 during the stagnant 1970s. That would slash the index’s trailing P/E down to 14x, implying that the S&P 500 (SPY) would fall to 3,052.
All in, Calvasina said that the 3,500 level on the S&P 500 (SPY) “will be key to watch, as it represents the point at which a median recession would be priced in.”
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