Morgan Stanley Research channels our prior discussion on earnings during recessions:
“We have heard investors suggest $80 in EPS was a fair bear case for 2012. We decided to look at history as a guide in assessing the bear case EPS. The 2001 recession saw a 13% revenue decline and a 57% EPS drawdown. The 2008 recession saw a 14% revenue decline and a 51% EPS hit, peak-to-trough. For 2012, bottom-up estimates (excluding financials) embed a 5% revenue INCREASE and just over 10% year-over-year EPS growth. If prior recessions prove relevant to next year’s economy, $54 to $68 in EPS in 2012 would be a more likely range than the $112 that the bottom-up consensus estimates currently embed.”
What should SPX prices be? Depends upon how much earnings fall during the coming slow down/recession. If we get a pre-2000 recession drop of 15%, then we are priced fairly. A 2001-recession like drop of 25% means more downside. Of course, the 2008 outlier — earnings plummeted 44% during the credit crisis — well, that means a whole lot more downside work in equities . . .
Hat tip Sam Ro
The investor’s dilemma: Earnings, valuations and what to do next (September 11th, 2011)
Is the S&P500 Cheap? (August 29th, 2011)
McKinsey: Equity Analysts Are Still Too Bullish (June 2nd, 2010)