The Stock Market Is in Free Fall. Here's One Way to Think About Where It Stops.

With a Saudi oil price war and coronavirus roiling markets, here’s how to create your own base-case and bear-case models for stocks

With a Saudi oil price war and coronavirus roiling markets, here’s how to create your own base-case and bear-case models for stocks

With a Saudi oil price war and coronavirus roiling markets, here’s how to create your own base-case and bear-case models for stocks

Wall Street is scrambling to price in a shock on top of a shock—a Saudi price war on oil, coming at a time when coronavirus fears are already cutting into demand for things like jet fuel. Investors are caught in a feedback loop of falling stock prices spreading pessimism, and pessimism bringing down stocks.

By Monday afternoon, the Dow Jones Industrial Average was down more than 1,800 points, or 7%, while the S&P 500 had tumbled 6.7%. The 10-year Treasury yield has sunk to 0.50% in a flight to safety. Oil was down 20%.

How bad could the downturn get? Here are some quick numbers to use to create your own forecast. The usual caveats apply: Past patterns might not apply this time. And I have no special ability to predict the short-term direction of the stock market. I always guess up, and always prepare for the possibility that I’m wrong, by keeping a healthy mix of stocks, bonds and cash.

At the beginning of this year, Wall Street predicted 2020 earnings would rise by a double-digit percentage, and investors familiar with how those estimates tend to come down closer to reporting time expected only mid-single-digit growth. By last week, however, zero growth seemed a better assumption. With the oil price in free fall, an earnings decline is starting to look more likely, and a recession isn’t off the table.

So let’s start with $165. That’s 2020 earnings per share for S&P 500 companies assuming negligible earnings growth. At Friday’s close of 2972 for the index, stocks traded at 18 times earnings. The historical average is about 15 times—it depends on which measure of earnings you use, and whether you use already-reported figures or estimates.

So stocks are a little expensive, but relative to ultralow bond yields—the entire U.S. yield curve fell below 1% over the weekend—stocks look reasonable. Still, they appear to be headed much lower on Monday.

So what would a recession do to earnings? There have been 11 recessions since 1947, and they have taken earnings down by a median of 13%, according to Goldman Sachs. But there’s a wide range, from single-digit declines to a 45% plunge during the global financial crisis.

A typical recession would bring S&P 500 earnings down to $143 and change. If we assume investors become less enamored of stocks, with the price-to-earnings ratio falling to 15, the S&P 500 would hit 2153. That’s a drop of more than 27% from Friday’s close—or another 20% from Monday afternoon.

Don’t panic. It’s too early to declare a recession imminent. And we’ve never seen interest rates this low, so we don’t know what effect that will have on the prices investors are willing to pay for stocks. If investors remain willing to pay 18 times earnings, a typical recession could bring prices down only 13% from Friday’s close.

I’m still guessing up, but I’m ready to be wrong, especially in the near term, until we break out of this gloom cycle. The options put/call ratio, watched as a contrarian indicator, isn’t quite back up to peak levels of the past decade. That could mean we haven’t reached maximum gloom yet.

Here are some scattered comments from Wall Street on Monday:

Deutsche Bank: “What matters for markets is when the second derivative of confirmed cases begins to flatten out, and if the US follows the path of China ex Hubei then that could happen within the next week or so.”

Morgan Stanley: “While all eyes remain focused on global growth concerns as the sole cause of the correction, Mike thinks such a view underestimates the fragility of the recovery prior to the outbreak and the existing headwinds that were already in place—earnings recession/margin pressures, tariffs and a Fed tightening cycle that probably went too far.”

Bank of America: “The S&P 500 now yields 2.5x the 10-yr Treasury yield, the highest level since 1951.” Also, “We reiterate our view from Sept-2019 and our 2020 year ahead that oil prices could make a 15 year new low in the low $20s.”

UBS: “Oil prices could speed down to, or through, the weakest levels of 2015/2016.” Also, “Credit induced hit to forward multiples could take S&P 500 towards 2650-2700.” Also, with regard to interest rates, “Zero lower bound to become market base case.”

Write to Jack Hough at

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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