How low can the stock market go? 4 scenarios that investors should consider

Bears who believe the S&P 500 has yet to bottom see the large-cap benchmark falling 15% to 35% from current levels, according to DataTrek Research co-founder Nicholas Colas.

With that in mind, the Wall Street veteran, in a note Thursday, outlined four downside scenarios for investors to consider:

3,386 – “the last pre-pandemic high for the S&P 500

Both the MSCI EAFE Index MFSU22,
-0.01%,
which measures stock market performance in developed markets outside the U.S. and Canada, and the emerging markets stock index, which are trading below their early 2020 levels, Colas noted.

“If the rest of the world’s stocks have already given up their pandemic gains, why should US large caps be any different,” Colas said.

3,236 – “a conservative forecast based on long-term US stock returns

The worst 20-year compound annual growth rate for the S&P 500 since the Great Depression was the period from 1999 to 2018, at 5.6% per year, according to Colas. If this is also a “fair” return assumption for the past five years, then note that the S&P 500 closed at 2,465 on September 7, 2017. Applying the same return would see the S&P 500 at 3,236.

3,000 – a nice round number

“Not only does 3,000 fit that bill, but it’s also exactly where the S&P closed on September 30, 2019 (2,977),” Colas noted. “This was shortly before the index rose 14% to its February 2020 highs, so this may be a more accurate representation of longer-term fair value.”

2,600 – “a surprisingly easy target to defend even if it is 35% below current levels

Historically, the S&P 500 has fallen an average of 25% around a typical U.S. recession, Colas noted, which would put the index’s earnings value at $171 a share. Put a P/E ratio of 15 on that, and assuming interest rates stay between 4% and 5% and compress stock valuations, the S&P looks at 2,565, according to Colas.

The S&P 500 SPX,
+1.53%
has been volatile this year with the large-cap index hitting 2022 lows in June and falling into a bear market. The index had its worst first-half performance since 1970, but rebounded partially from its June 16 low, where the S&P 500 closed at 3,667, down 23.6% from its high.

The S&P 500 opened 1.4% higher at 4,062 on Friday. The Dow Jones Industrial Average DJIA,
+1.19%
and the Nasdaq Composite COMP,
+2.11%
rose 1.2% and 1.9%, respectively.

Colas, meanwhile, noticed a curious thing about predictions of low stocks: “nobody seems to be buying when they come true.”

Colas argued that the phenomenon does, in fact, explain why bottoms occur.

“Investors throw away the math because there is always a lower possible price target that looks just as justified relative to current levels. Persistent volatility is crushing investor confidence so that any S&P price target looks likely,” he wrote. “Whether you’re bullish or bearish, this is a critical point to keep in mind in the coming weeks and months.”

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