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
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.
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 /
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.
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
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