S&P 500 Valuations Below Recessions Since ‘57

By Lu Wang, Inyoung Hwang and Rita Nazareth - Oct 3, 2011 8:51 PM GMT+0700
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A pedestrian passes in front of Standard & Poor's Financial Services LLC in New York, U.S. S&P 500 profits fell an average of 12 percent on a yearly basis in the nine recessions since the 1950s, according to data compiled by Bloomberg. Photographer: Scott Eells/Bloomberg

The rout that erased $2.9 trillion from U.S. equities has pushed valuations in the Standard & Poor’s 500 Index 25 percent below the average level from the last nine recessions, even as profit estimates fall.

Companies in the benchmark gauge for American equities trade at 10.2 times 2012 forecast earnings, compared with the average in economic contractions since 1957 of 13.7, according to data compiled by Bloomberg. At the same time, analysts have cut projections for profits next year by 2.6 percent to $110.78 a share, the biggest eight-week drop since 2009, the data show.

Bears say analysts have just started paring earnings estimates and that shares will prove expensive when gross domestic product shrinks. Bulls say stock prices have fallen so much that even should earnings fail to increase in 2012, equities are inexpensive.

“What you’re seeing is a growth scare,” Wayne Lin, a money manager at Baltimore-based Legg Mason Inc., said in a telephone interview on Sept. 29. His firm oversaw $643 billion as of Aug. 31. “The question is, how much of that is priced in. I’d say that if we don’t have a double-dip recession, if earnings just stay flat, these valuations are reasonable. The market already expects those downgrades.”

Chinese Manufacturing

The S&P 500 fell 0.3 percent to 1,128.64 at 9:43 a.m. in New York. The U.S. benchmark gauge slipped 0.4 percent last week, extending its decline since July 22 to 16 percent, after reports showing Chinese manufacturing shrank and retail sales in Germany slumped fueled concern global growth is slowing. The index had climbed 67 percent since March 2009, with 455 of its members higher than their level at the bottom of the bear market.

Concern Europe’s debt crisis will trigger a global recession spurred investors to seek safety in the dollar and Treasuries during the third quarter. The U.S. currency’s 5.7 percent increase was topped only by U.S. bonds, which rallied 6.4 percent, according to Bank of America Merrill Lynch’s U.S. Treasury Master Index data. The S&P 500 tumbled 14 percent, the most since 2008, and the S&P GSCI Total Return Index of commodities lost 12 percent.

Analysts have slashed forecasts for 2012 earnings to the lowest level since April, data compiled by Bloomberg show. Projections have been falling for companies from JPMorgan Chase & Co. (JPM) to Caterpillar Inc. (CAT) since S&P stripped the U.S. of its AAA credit rating on Aug. 5.

Credit Crisis

The downgrades will get worse, according to Thomas O’Halloran, a Jersey City, New Jersey-based money manager at Lord Abbett & Co., which oversaw about $114 billion as of June 30. O’Halloran said profits will decrease by at least 15 percent in 2012 from this year. The average forecast of Wall Street analysts shows earnings will climb 17 percent to a record $99.17 a share this year and increase in 2012, data compiled by Bloomberg show.

Analysts underestimated the credit crisis that began in 2007 and cut forecasts throughout 2008 when the economy contracted. The reduction in profit estimates didn’t end until May 2009, two months after the benchmark sank to a 12-year low, Bloomberg data show.

“The sovereign-debt crisis is more scary than the private- bank crisis, because the sovereign can backstop the private sector but there is nobody to backstop the sovereign,” O’Halloran wrote in an e-mail on Sept. 28. “We’re in an environment where the macro is terrible. That would be the underlining reason why the market could have further downside.”

Recession Looms

International investors expect the world economy will relapse into a recession, with more than one in three forecasting a global economic contraction within the next year, according to a Bloomberg Global Poll conducted Sept. 26. More than two in five said they’re increasing holdings of cash, the largest proportion since the poll began asking that question in June 2010. A majority, 56 percent, say U.S. stocks entered a bear market.

S&P 500 profits fell an average of 12 percent on a yearly basis in the nine recessions since the 1950s, according to data compiled by Bloomberg. Should earnings drop by the same amount from the estimated $99.17 a share this year, profits will total $87.59 in 2012. Based on the S&P 500’s Sept. 30 close of 1,131.42, that would imply a multiple of 12.9.

‘Second Dip’

“We’re diving into the second dip of a double-dip recession, so how promising is it that the earnings will hold?” Rob Arnott, chairman and founder of Research Affiliates LLC in Newport Beach, California, said in a telephone interview on Sept. 28. About $83 billion is managed using investment strategies developed by his firm.

“The measures by which stocks are cheap today rely on continued recovery and a continued surge in already peak earnings,” Arnott said. “It relies on a very shaky foundation.”

Economists project growth will accelerate to 2.2 percent in 2012 from 1.6 percent this year, according to a Bloomberg survey of 66 respondents. U.S. gross domestic product expanded at a 1.3 percent pace in the second quarter, according to a Commerce Department revision released Sept. 29.

Should S&P 500 earnings hold at $99 a share next year, stocks would be trading at a 30 percent discount to the average multiple since 1954, according to Bloomberg data. The index is priced at 12.3 times earnings in the last 12 months, down from a high of 23.9 in December 2009.

Train Wreck

Companies exceeded income forecasts in the last nine quarters after cutting costs and lowering debt. Reduced estimates mean corporations will have an easier time extending the streak, said Brian Jacobsen, chief portfolio strategist for the mutual-fund division at Wells Fargo Asset Management. Unlike 2008, when the bankruptcy by Lehman Brothers Holdings Inc. came as a shock, the market is anticipating a recession and the pessimism is overdone, he said.

“The current crisis seems almost like a train wreck that everybody is witnessing,” Jacobsen, who is based in San Francisco, said in a telephone interview on Sept. 29. His firm oversees more than $400 billion. “That’s one of the reasons why I think we’ll avoid a train wreck. Policy makers know what the issues are. They just have to come to an agreement.”

Twenty-two of the 31 analysts who follow JPMorgan slashed their 2012 earnings projections in the past four weeks, and none raised them, data compiled by Bloomberg show. The New York-based bank is trading at 5.71 times next year’s earnings of $5.29 a share. That’s 45 percent lower than the average multiple since 2004, according to data compiled by Bloomberg.

Caterpillar

The average profit estimate for Caterpillar, the largest maker of construction and mining equipment, fell by 36 cents to $8.86 a share in the past four weeks, according to a Bloomberg survey of 21 analysts. Shares of the Peoria, Illinois-based company are trading at 8.20 times 2012 earnings, 38 percent below the average valuation since 2005, Bloomberg data show.

Matt Peron, head of active equity at Northern Trust Corp. in Chicago, said the economy will avoid a recession.

“Estimates will come down a fair amount, but I don’t think they’ll fall to something like an $85 level,” he said in a Sept. 29 interview. His firm manages $684 billion. “If they don’t, there’ll be a relief rally or the market will at least grind higher when it realizes it’s been pricing in too low of a number.”

To contact the reporters on this story: Lu Wang in New York at lwang8@bloomberg.net; Inyoung Hwang in New York at ihwang7@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net