Stocks have been wildly decoupled from fundamental corporate earnings since 2015. This crash could drag the market back down to reality.
Welcome to the fastest bear market in history. The U.S. stock market has collapsed 27% in a little over three weeks, wiping out tens of trillions of dollars.
Some investors may be looking to ‘catch the falling knife’ and start buying stocks while there’s blood in the streets.
But this isn’t over yet, according to this chart published by Lance Roberts, chief strategist RIA Advisors.
This chart tracks the S&P 500 (blue line) against actual corporate profits (orange line). As you can see, the stock market has been out of whack and decoupled from fundamentals since 2015.
In other words, the stock market was way overvalued even before the coronavirus hit.
A basic mean reversion would see the S&P 500 correct back down to the 2,000 level. That’s a further 20% from today’s prices. And that’s before we throw in the impact of a recession on corporate profits.
The impending recession, and consumption freeze, is going to start the mean-reversion process in both corporate profits and earnings.
The chart above was originally published before the coronavirus panic swept the markets. Now there’s a very real threat of a recession. That means that corporate profits will likely decline below the current level. It leaves us with a chart that looks more like this:
With that in mind, Roberts gives a conservative estimate of 1,800 for the S&P 500 – a drop of 27% from today’s prices.
The resulting decline in asset prices to revert valuations to a level of 18x (still high) trailing earnings would suggest a level of $1800 for the S&P 500 index.
This might be the fastest bear market in history, but it’s not the deepest, yet. As you can see in the chart below, published by The Block’s Larry Cermak, we’ve got a long way to go if this tracks the 2001 or 2008 bear markets.
Roberts said it’s unlikely the market has bottomed yet, citing three distinct phases of a bear market. First, the initial drop. Second, the optimistic rebound. And third, the slow grind down until there are almost no buyers left.
Just like in 2000, and 2008, the media/Wall Street will be telling you to just “hold on.” Unfortunately, by the time “Phase 3” was finished, there was no one wanting to “buy” anything. That’s how you know a “bear market” is over.
We’ve already seen a few optimistic dead cat bounces. But we haven’t seen the slow bleed lower yet. Strap in. This could get ugly.
This article was edited by Samburaj Das.