Jamie Dimon says don’t be surprised if the S&P 500 loses another one-fifth of its value. While such a plunge would fray trader nerves and stress retirement accounts, history shows it wouldn’t require any major departures from past precedents to occur.
Judged by valuation and its impact on long-term returns, the JPMorgan Chase chief executive officer’s “easy 20%” tumble, mentioned in a CNBC interview yesterday, would result in a bear market that is in many regards normal. A decline roughly to 2,900 on the S&P 500 would leave the gauge 39% below its January high, a notable collapse but one that pales next to both the dot-com crash and global financial crisis.
The price implied in Dimon’s scenario is roughly the index’s peak from 2018, the year when President Donald Trump’s corporate tax cuts took effect and an equity selloff forced the Federal Reserve to end rate hikes. Rolling back the gains since then would leave investors with nothing over four years, a relatively long fallow period. But, given the force of the bull market that raged before then, it would cut annualized gains over the past decade only to about 7%, in line with the long-term average.
Nobody knows where the market is going, Dimon included, and much will depend on the evolution of Federal Reserve policy and whether earnings stand up to its anti-inflationary measures. As an exercise, though, it’s worth noticing that a drawdown of the scope he described isn’t unheard-of, and would strike many Wall Street veterans as a justifiable reckoning in a market that had been carried aloft by the Fed’s generosity.
Falling interest rates had “been great for valuation multiples and we’re unwinding all of those,” Michael Kelly, global head of multi-asset at Pinebridge Investments LLC, said on Bloomberg TV. “We’ve had easy money for a long time and we can’t fix all of that very quickly.”
At 34%, the average bear market since World War II has been a bit shallower, but the drops vary enough that a 40% plunge fits within the bounds of plausibility. One reason the current drawdown may have legs is valuation. In short, even after losing $15 trillion of their value, stocks are far from being obvious bargains.
At the low last month, the S&P 500 was trading at 18 times earnings, a multiple that is above trough valuations seen in all previous 11 bear cycles, data compiled by Bloomberg show. In other words, should equities recover from here, this bear market bottom will have been the most expensive since the 1950s. On the other hand, matching that median would require another 25% drop in the index.
“We had a period of a lot of liquidity. That’s different now,” said Willie Delwiche, an investment strategist at All Star Charts. “Given what bond yields are doing, I don’t think you can say a 40% peak-to-trough decline is out of the question.”
Would the S&P 500 become a bargain if a 20% drop played out? It’s debatable. While 2,900 is quite cheap relative to existing estimates for 2023 earnings -- about $238 a share, implying a P/E ratio of 12.2 -- those estimates would be in serious trouble should a recession occur, as Dimon predicted. Adjusting forecasts for a 10% fall in profits yields an earnings multiple of 14.3 -- not expensive, but not a screaming bargain, either.
Underlining Dimon’s gloomy outlook is the threat of an economic contraction. From surging inflation to the Fed’s ending quantitative easing and Russia’s war in Ukraine, a number of “serious” headwinds are likely to push the US economy into a recession in six to nine months, the JPMorgan CEO told CNBC.
Dimon’s assessment on the economy and market appears more ominous than his own in-house forecasters. Michael Feroli, JPMorgan’s chief US economist, expects real gross domestic product to expand every quarter through the end of 2023.
While market strategists led by Marko Kolanovic admitted their year-end targets for financial assets may not be reached until next year, the team kept their upbeat tone on corporate earnings. It had expected the S&P 500 to rally to 4,800 by December.
“Equities are proving to be an effective real asset class as their earnings are linked to inflation,” the team wrote in a note last week. “Unless nominal GDP growth downshifts drastically, earnings growth should remain resilient and defy expectations of a decline even in an environment of low real GDP growth.”
The clashing views underscores the reality of the post-pandemic world where Wall Street forecasts vary and efforts to predict the future have proved futile. Central bankers and investors alike misjudged the stickiness of inflation. Lately it’s become clear that retailers and chipmakers miscalculated demand and ended up stocking too many unwanted goods.
With the Fed engaged in the most aggressive monetary tightening in decades, no one can say with high conviction where the economy is going. That murky backdrop has led to a wide range of projections when it comes to corporate profits for next year -- a 13% expansion to an 8% contraction, based on strategists tracked by Bloomberg.
Jane Edmondson, chief executive officer at EQM Capital, says she’s more optimistic than Dimon, though she shares the concern over the Fed’s inability to address the supply side of the inflation issue.
“I would agree that if the Fed does not slow down on its quest to combat inflation, we could see more market pain,” she said. “While their hawkishness with interest rates may curb some demand, it does not solve the issues in the supply chain causing higher prices and inflation. In that sense, Jamie’s concerns are warranted as the cure is not appropriate for what ails us.”
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