3 Earnings Scenarios
Our starting point is 2019 earnings per share (EPS) of $163 and 3,379 for the S&P 500 Index (SPX), the ending point is the high in January 2020.
- The first scenario (U) assumes a modest 5% hit to EPS over the coming 2 quarters, followed by a trend-line growth rate of 8% (the expected growth rate prior to COVID-19). This scenario would see EPS bottom at $156 in Q2 and then rebound to $161 in 2020 and $172 in 2021—a recovery delayed but not canceled.
- The second scenario (V) is a one-time hit of 10% over 2 quarters (down to $147 in Q2) followed by a V-shaped recovery to $159 in 2020 and $186 in 2021. Think of it as the earthquake scenario where demand gets hit hard and then comes roaring back.
- The third scenario (L) is a one-time hit of 10% over 2 quarters followed by the same moderate trend-like 8% growth rate that was expected. In this scenario, EPS falls to $147 as before, but only rebounds to $152 by the end of 2020 and $163 in 2021 (so, it ends up where it is now).
2 Valuation Scenarios
Best-case scenarios
From here it becomes a matter of applying the appropriate valuation multiple. Let's optimistically assume for now that the market should be valued at 19x trailing earnings, below the recent peak of 20.7x but in line with where interest rates and inflation are.
In the U-shaped scenario, the S&P 500 should decline 13% from the highs, to 2,956. Compared to the low of 2,857 that we saw 2 Fridays ago, the market has already corrected more than it needed to. That suggests that the bottom is in place and the market can build its base before it moves back up (to 3,058 in 2020 and 3,271 in 2021).
In the V-scenario, the S&P 500 would fall to 2,795 from the highs for a total decline of 17% from the highs. That means that the S&P 500 has corrected almost as much as it should have (to the low of 2,857) and has upside to 3,023 in 2020 and 3,537 in 2021.
In the L-scenario, we would also see a decline of 17% from the peak, followed by a slower rebound to 2,891 in 2020 and 3,093 in 2021.
Worse-case scenarios
Now let's take a lower multiple of say 17x, and see where we come out. At a 17x multiple and using the above 3 earnings scenarios, we would get the double-whammy of both an EPS decline and a valuation haircut.
In the U-scenario, we get to a bottom of 2,645 for a decline of 22% from the high (crossing slightly into bear market range), and in the L-scenario, we would get a decline to 2,501. That would be a 26% decline and would put us firmly in bear market territory.
From there we would recover slowly or swiftly, based on the earnings recovery and more importantly the magnitude of multiple-expansion off the lows.