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									                                    Global Equity Strategy
                                      U.S. Sector Watch
                                    Equity Research / North America

                            Of Earnings and Targets                                                                                            August 22, 2011
                            Sam Stovall, Chief Investment Strategist

                            For the past four weeks, equity prices underwent a violent adjustment, as investors attempted to trim
                            earnings expectations based on how severe they perceived the next potential recession to be. And
                            since the future of both the economy and earnings is unknown, investors have had to deal with a
                            double “what-if” analysis, making for wide variations of earnings projections, as well as price
                            correction assumptions. Add in fear of the unknown, and you can see why the market’s volatility has
                            been so great. Yet if the market action in 2008 taught us anything, it was: Be proactive and expect the
                            worst. With that in mind, how far could S&P 500 operating EPS fall should the U.S. slip back into
                            recession, and as a result, where might the S&P 500 bottom out in anticipation of these EPS
                            revisions? Maybe a good place to start would be by looking at the average EPS decline during
                            recessions since 1948, remembering, of course, that while history is a great guide, it is never gospel.

                                                                       S&P 500 Market Tops Versus Earnings Peaks
                                                                                                                                                          Low P/E
                               S&P 500        Recession         # Mos.          EPS         Mos. After       Avg. EPS         EPS         Mos. After       in Mkt.
                                 Top             Start         After Top        Peak        Market Top       % Decline       Trough       EPS Peak        Decline
                                Jun-48         Nov-48              5           Jun-49          12               (3)          Dec-49          6                6
                                Jan-53          Jul-53             6             NA             NA              NA             NA           NA               NA
                                Aug-56         Aug-57             12           Mar-56           (5)            (22)          Sep-58         30               12
                                Aug-59          Apr-60             8           Sep-59           1              (12)          Jun-61         21               16
                                Nov-68         Dec-69             13           Sep-69          10              (13)          Dec-70         15               13
                                Jan-73         Nov-73             10           Sep-74          20              (15)          Sep-75         12                7
                                Feb-80         Jan-80             (1)          Mar-80           1               (5)          Mar-81         12                7
                                Nov-80          Jul-81             8             NA             NA              NA             NA           NA               NA
                                Jul-90          Jul-90            (0)          Jun-89          (13)            (24)          Dec-91         30               13
                                Mar-00         Mar-01             12           Sep-00           6              (32)          Dec-01         15               19
                                Oct-07         Dec-07              2           Jun-07           (4)            (57)          Sep-09         28               17
                               Median                              8                             1             (15)                         15               13
                                Mean                               7                             3             (20)                         19               12
                             Source: S&P Equity Research, NBER, Past performance is no guarantee of future results. GAAP EPS 1948-1980. Operating EPS thereafter.

                            Since 1948, the S&P 500 topped out a median eight months, and a mean of seven, before the
                            recession started and one-to-three months before earnings peaked. In the subsequent 15-19 months,
                            EPS (GAAP EPS from 1948-1980, operating EPS thereafter) declined 15% to 20%. And during all
                            market sell-offs, stock prices traded at an average low multiple of 13X-12X on trailing results.
                            Applying that historical backdrop to today, the S&P 500 EPS of 93.29 reported by S&P’s Capital IQ
                            for the second quarter of 2011, and assuming the U.S. does slip into recession and earnings trade
                            between 12X and 13X, the S&P 500 could ultimately bottom in a range of 900 to 1030.

                                                     S&P 500 Levels Based on Historical EPS Declines and Low Multiples

                                                             EPS                                        Implied S&P 500 on P/E Ratios
                                          Current          Revised           Decline              12            13         14          15
                                          $93.29           $79.30             15%                952          1031       1110         1189
                                          $93.29           $74.63             20%                896           970       1045         1119
Standard & Poor’s Equity
                                       Source: S&P Equity Research, Capital IQ.
   Research Services
    55 Water Street
     New York, NY           Of course, a lot of “ifs” would have to be met, such as recession, declining EPS, eroding market
         10041              multiples, etc. Yet this target price range of 900-1030 based on EPS declines also approximates the

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Equity Research /
North America

                         average S&P 500 price declines of 22% to 30% associated with recessions since 1948, which places a
                         potential decline from the April 29 recovery high of 1363 to between 960 and 1070.

                                Source: Bloomberg

                         Finally, plotting a regression on to the log-scale growth of the S&P 500 since its low in 1932, we see
                         that should the S&P 500 revisit the level representing two standard deviations below the mean (as it
                         did in 2009), the “500” would only need to fall into the 900-1000 area, due to the passage of time and
                         the Index’s upward trajectory. In other words, the S&P 500 would not have to challenge the March 9,
     Standard & Poor’s   2009 low of 676 in order to register an extreme level of selling and offer a great buying opportunity.
      55 Water Street
       New York, NY
          10041          2
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Standard & Poor’s                                                                                                                                                               3
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Standard & Poor’s                                                                                                                                                                       4
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