As a few more chunks of ground fell away beneath most of the world’s stock markets Tuesday, investors find themselves increasingly staring into a dark abyss – and wondering when they’ll finally hit the bottom.
“It’s very hard to answer this, because this market makes no sense,” said Vincent Delisle, market strategist at Scotia Capital in Montreal.
Investors managed to find some solid footing in the crumbling markets Tuesday, as an afternoon rebound pulled the U.S. indexes out of the red and pared much of Toronto’s deep early losses. But that was after overseas bourses suffered another day of sharp declines, and the Canadian benchmark index tested two-year lows.
The S&P/TSX composite index rebounded from more than 400 points down to finish at 11,177.91, off a relatively modest 77.93 points – its third losing day in a row, and fourth in a five-session stretch in which it has shed 6 per cent. The Canadian benchmark is now down nearly 12 per cent since the end of August, and nearly 22 per cent from its April peak. Stocks have just come through their worst quarter since the market crash of 2008.
To many observers, that kind of plunge defies logic; economic and credit conditions are considerably healthier than they were three years ago. Still, with fears of a recession and a European debt disaster driving losses beyond the 20-per-cent threshold that traditionally defines a downturn as a full-fledged “bear market,” strategists are putting logic aside and looking for historical precedents that could give clues as to where the markets might finally find a bottom.
“The average bear market decline is closer to 30 per cent than 20 per cent,” Mr. Delisle said. “So the downside might be another 8 [to]10 per cent.”
Comparisons with the 2008-09 crash – when fears of the unknown and a deep lack of faith in corporate earnings forecasts reigned – are inevitable. At the lows of March, 2009, the S&P 500 carried a price-to-earnings valuation of about 10 times earnings – which was right about the valuation of the U.S. benchmark at Tuesday’s lows, based on Wall Street’s consensus 12-month forward earnings forecasts. A similar P/E would point to an S&P/TSX level of 10,750, within 100 points of Tuesday’s lows.
To some, that suggests we may already be near the bottom – and, indeed, that may have contributed to the rebound in stocks from Tuesday’s mid-session lows. But others say it’s evidence that the Street’s earnings estimates aren’t believable any more.
“The lows [for stock markets]will be determined by whether or not the economy slips into recession,” said David Rosenberg, chief economist at Gluskin Sheff + Associates Inc. “If it does, and there is good reason to believe that it will, then earnings will likely be in for a 20-per-cent haircut.”
If you assume that degree of decline in S&P 500 profits, combined with a historically typical recession P/E multiple of about 12, you end up with an S&P 500 bottom of about 950 – another 15 per cent below current levels.
But if there’s no U.S. recession, he said, “then now would be a good time to start chipping away. Once the market is down 10 to 20 per cent and there is no subsequent rupture on the real economy, as we saw in 1966, 1987, 1994 and 1998, declines of the magnitude we just endured turn out to be attractive buying opportunities.”
David Kostin, head of U.S. portfolio strategy for Goldman Sachs in New York, said his firm’s “uncertainty-based model” – developed to try to incorporate investors’ levels of fear into pricing assumptions – suggests that S&P 500 P/E multiples could slip as low as 8.3 at the bottom of the model’s range for the coming months, which would imply a low for the index of about 920. However, he said, the midpoint of the model right now points to a P/E of 9.4 – which would equate to an S&P 500 of 1,040.
But Mr. Delisle said P/E valuations can become quite meaningless in market selloffs such as the current one, which are fed more by fears than by fundamentals.
“Valuations, more often than not, are a trap,” he said. “Anything that’s cheap today was cheap two weeks ago, was cheap a month ago.
“There’s just bearish sentiment everywhere. The bears don’t even have to make a good case for it.”