The Recession Is Already Priced Into Stocks

by: Greg Feirman October 24, 2008 | about stocks: DOW / SPY / UPS    

Greg Feirman

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On February 8th, with the S&P trading around 1330, I wrote “Stocks Now Priced For Mild Recession”.

Because I was expecting a severe recession, I didn’t yet feel that stocks fully discounted what was on the horizon.  Nine months later and 460 points lower, I believe that a severe recession is now priced into stocks.

The economy is going to be terrible in 2009.  Yesterday morning, UPS reported a 3.4% decline in average daily volume of US packages for the 3rd quarter (UPS 3Q Earnings Release).  Dow Chemical (DOW) reported a 9% decrease in global sales volume, including a 15% drop in North America for the 3rd quarter (DOW 3Q Earnings Release - see pg. 11).  These are clear indications of an economy going into a deep recession.

But stocks valuations now reflect this.  UPS is trading for about 13 times this year’s earnings.  DOW is trading for about 8 times.  Even if earnings drop by 25% in 2009, these stocks are not expensive.

I think the same can be said for the S&P 500 as a whole.  Peak earnings for this cycle (3Q 2006 - 2Q 2007) were $85 for the S&P as a whole.  Even if that drops by 25% in 2009, that’s $64, which is a 13.6 forward multiple on the current price (1370).  If earnings drop by 40% next year, a depression-like outcome, the forward multiple for the S&P is still only 17.  It feels to me as if stocks are, at current prices, already discounting some really bad outcomes.

As I wrote about on Wednesday, many of the best investors in the world see value at these levels. 

Following up on his NY Times Op-Ed, Warren Buffett on Wednesday told a crowd at the Long Beach Arena in California that his personal account is now 100% invested in US stocks.

Yes, 2009 is going to be bad.  Yes, the economy is heading for a severe recession.  But it’s discounted by stocks at this point.  Unless you think we’re headed for a stock market crash or depression, now is a time to buy stocks.

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This article has 30 comments:

  •  
    Oct 24 04:05 PM
    what about the unknow of credit default swap? has that been priced in? If so, how do you determine that?
    Reply | Link to Comment
  •  
    Oct 24 04:09 PM
    We might be heading into depression...
    Reply | Link to Comment
  •  
    Oct 24 04:54 PM
    Dude - this article is RUBBISH. During the housing boom (a.k.a. "credit free-for-all") stocks, like real estate, became greatly OVERVALUED. Now they are STARTING to return to normal valuations.

    Your last comment is just precious - " Unless you think we’re headed for a stock market crash or depression, now is a time to buy stocks." YEAH RIGHT. LMAO. FYI Greg - we are in the MIDST of a STOCK MARKET CRASH !!! One year ago the Dow was at 13,675, today it closed at 8,378, and there is NO END IN SIGHT. CAN YOU SAY CRASH?

    So sure, if you want to catch a FALLING KNIFE, buy stocks. If you want to lose even more money, buy stocks. Thanks for the advice, Greg.


    Reply | Link to Comment
  •  
    Oct 24 05:01 PM
    past p/e multiples do not apply. we are in the midst of a cyclical deleveraging not seen since the 30's, and on a global basis. you cannot expect future profits and p/e's to be valued the same moving forward.

    periods of the 1990's/2000's where credit/financing was easier to obtain for corporations and the customers of their products. I cannot predict whether we are close to a bottom or not, what I will predict is that although we will have rallies, it will be many years before we begin a new, legitimate bull market. We must find who the new leaders will be in this new environment before this can happen.
    Reply | Link to Comment
  •  
    Oct 24 05:50 PM
    "Unless you think we’re headed for a stock market crash or depression, now is a time to buy stocks."

    Well, that says it all. Let me paraphrase: "unless you think the market is going down, you should buy stocks". OK.
    Reply | Link to Comment
  •  
    Oct 24 06:53 PM
    Cramer said we've seen the bottom. In fact, he's pointed that out pretty much once-a-week since April, so it's got to be true.
    Reply | Link to Comment
  •  
    Oct 24 06:53 PM
    I'd wait for signs of a bottom before buying, except for a few oversold bounce-back candidates, like AAPL (I'm long). The stock market tends to overshoot--why not wait for it to get even cheaper? Especially since there's lots of forced selling in the pipeline.
    Reply | Link to Comment
  •  
    Oct 24 08:08 PM
    Can buy but I think more for trading. To buy and hold we run the risk of catching falling knives never mind that Warren Buffet and many others are 100% invested.

    As I survey the world situation in its totality, I still sense trouble ahead. I would rather trade than buy and hold.
    Reply | Link to Comment
  •  
    Oct 24 08:45 PM
    Past p/e multiples do not apply? What kind of nonsense is that? The fundamental maths of finance are still operative. A P/E of 8 = 12% ROI. With fixed income funds in low single digits sooner of later the pressure to get better returns will overwhelm and equities will explode.
    Reply | Link to Comment
  •  
    Oct 24 09:01 PM
    I think it's important to read this article on this site...

    Coming Soon: The $600 Trillion Derivatives Emergency Meeting

    seekingalpha.com/artic...

    Throw this amount in with the "multiplier effect" and we are looking at something much worse than the Great Depression. You'll think the Dust Bowl days were the good ol' days when this sucker goes down.

    Put simply, there is not enough to go around to save even a small fraction of the cascade of things that will come falling down. GM, Ford and Chrysler here, maybe Bank of America, GE and Wells Fargo the week after that, then, then, then... There are tens of thousands of foots to drop on this economy. I don't think we've even got started yet. In fact, we are only in the warm-up stage...

    The markets are well overvalued, especially considering that most of them have been hyped-up so long, nobody knows what the real value of any of these companies is anymore. Large caps. mid caps and small caps... The same story... What are any of them REALLY WORTH?

    And this economy... Let me give you an example of something on the ground... Go into a grocery store and look at a basic bag of potato chips -- not the giant bag, just your basic bag of chips. What is it now $4.00-$5.00? Do you think people are buying these things? Ask the manager at the grocery store -- NO WAY! So all of these stocks that people are pushing are just as worthless as everything else. Very few people can afford chips at that price and if you are the company making those chips, your days are numbered and your stockholders screwed. People aren't making the money required to buy all of this garbage at these prices. Go to a store and really take a look around.

    This country's economy is in BIG TROUBLE. I think fair value of the Dow may be 5,000 or even 4,000. Then you can buy, buy, buy...
    Reply | Link to Comment
  •  
    Oct 24 10:09 PM
    I'll play devil's advocate. I think stocks are still overpriced, and that earnings are likely to crash worldwide:

    2/3rds of U.S. economy is consumer spending. And that's just starting to nosedive, will get a lot worse. Consumer debt is at record levels (not to mention gov and corporate).

    Layoffs just picking up speed now, don't see unemployment improving in the foreseeable future.

    Non-saavy investors are just now realizing something is wrong. Many will be pulling their money out soon. Yes, there is a lot of $ on the sidelines, but I think most of that is very skeptical and has lost it's risk-appetite.

    1/6 homeowners underwater on their mortgages. And his may be only the first wave of foreclosures. Alt-A loans and commercial are starting to look ugly.

    Unfathomably large derivatives market adds to the chaos. Honestly, I don't understand this one completely. But what I do understand ain't pretty.

    Add to this unfunded medicare and social security costs of around $35 trillion, with baby-boomers retiring.

    Call me a pessimist, but I'm holding my short positions (while it's still legal) and not buying much yet. Looking to buy gold bullion once it gets cheap enough. Seems like deflation will eventually give way to inflation with the inevitable $ printing presses running.
    Reply | Link to Comment
  •  
    Oct 24 10:11 PM
    All this talk of a possible recession is just funny IMO. What else could be the possible outcome for any economy after seeing equity markets drop 30% in the blink of an eye. The markets are forward looking vehicles and they're giving a very simple view of where the overall economy is heading.
    Reply | Link to Comment
  •  
    Oct 24 10:34 PM
    Your article is dead on. Bill Gross will be saying the same thing on CNBC five days from now and everyone will think he is an astounding visionary. Maybe in 1929 you may have been able to bet against the United States of America, and maybe by 2029 we'll be underwater. But anyone betting against the United States at this point is going to be underwater quicker than a subprime mortgage. Its soooo 2008.
    Reply | Link to Comment
  •  
    Oct 24 10:41 PM
    For once I'm the optimist.

    I would go long, but my advice: "Balance and moderation."

    Small stakes in solid companies, and diversify. For those researching IRA's or long term I would be taking small positions in large/mid cap index funds/ETF's...

    Otherwise, timing is everything and better to be sitting on the sidelines.

    Disclosure: long mid-cap index funds.
    Reply | Link to Comment
  •  
    Oct 24 10:42 PM
    I loved the article but this statement "Unless you think we’re headed for a stock market crash or depression, now is a time to buy stocks." is just down right stupid. We're in a crash in case anyone noticed.
    Reply | Link to Comment
  •  
    Oct 24 10:42 PM
    Jimmy, Jimmy, Jimmy

    If only economies functioned on flag-waving, we'd corner the market. Unfortunately, there are other factors that will make our economy toast.

    Although it will be fitting... After all, derivatives, as Bruce Springsteen would sing, were born in the U.S.A. But, that's only the start...
    Reply | Link to Comment
  •  
    Oct 24 10:44 PM
    TA:

    And only at the initial stages of a crash I might add... Lots more shoes to drop as this sucker goes down. Shoes you didn't even know you had...
    Reply | Link to Comment
  •  
    Oct 25 01:08 AM
    I watched Cramer the other day and he said he didn't know if this was a bottom, and he wouldn't be surprised if it weren't. He says enough kooky things as it is without people putting words in his mouth. I don't know why all of you hate him so much, it's a show for stock-pickers, just take it for what it is.
    Reply | Link to Comment
  •  
    Oct 25 01:25 AM

    From my continuous reading of the financial crisis issues i have come to the conclusion that all the problem comes down to the deleveraging process of the financial institutions. It doesn´t matter how much capital you pour into banks, there are sizable sectors that will continue to deleverage. And i refer to hedge funds.

    I think that Hedge Funds should be forbidden of selling assets, at least in a desorganized fire sale way. Hedge funds should be put into quarantine and redemptions from hedge funds should be halted.

    This will relief the markets from the selling pressure that it is suffering right now.

    This Hedge fund freeze should be in the interest of the normal people and for the hedge fund participants also, as their assets will not be sold into a fire sale but into a more organized market.

    Certainly Treasury Secretary Paulson could verify this alternative. He, more than anybody understands the hedge fund world. Certainly some banks with exposure to hedge funds could suffer, so those banks should be pumped with the necessary liquidity and capital to avoid their failure.

    Best Regards
    Reply | Link to Comment
  •  
    Oct 25 02:07 AM
    i would like to point out that the comments are mixed on what will happen next. this is not a good sign as panic has not set in.

    to invest now, without:
    1) any indication how deep the recession will be
    2) grasp of extent of cdo/cds fallout
    3) stability in the currency market
    4) a bottom in the housing market
    means you are just gambling. nobody knows $hit, and this article is written by somebody who wants to play with your money.

    i have nothing to gain by advising you to be in an asset preservation mode until this plays out. leverage which caused this bubble will not be powering the market post-recession. past economic principals may or may not apply.
    Reply | Link to Comment
  •  
    Oct 25 05:41 AM
    When will all the worshipers stop bowing down to their god, Warren Buffet?

    Does anyone with a brain really think that anything this guy says at this point means squat?

    Imagine, if you will, that Buffet thinks, just maybe, really thinks that we are in for a long term, severe recession. Now, if this were the case, DOES ANYONE REALLY THINK BUFFET IS GOING TO SAY THAT PUBLICLY? Cause he isn't. Not in a million years; because if he did, the market would drop like a rock (and his stocks, too, would be in the toilet.)

    So he is doing what most people in the public eye are doing, what most TV talking heads are doing, and that is, LYING to try and minimize the damage.

    If this doesn't make sense to you, then by all means go out and buy stocks and watch your portfolio shrink, and shrink some more. But first, for your own sake, do some research and get your head out of the pie-in-the-sky nonsense. This economy is going down big time, and so is the stock market.

    I'm putting my money where my mouth is and am now in double inverse, index ETFs. And in a few months, (or weeks) you bulls are going to wish you had been, too.
    Reply | Link to Comment
  •  
    Oct 25 11:09 AM
    Because it's very difficult to estimate forward earnings in a volatile and pressured environment, my rule of thumb when doing fundamental analysis has been that unless I can come up with a compelling contradictory scenario, to assume a 50% decline in unit sales (of whatever a company sells) and a 500bp decline in margins. In most cases this will put the company in the red. Obviously there are sectors where this will not apply; e.g., foodstuffs and consumer staples. But if one looks at Volvo's order book one can see how even this might be far too optimistic.

    The winners in this environment will be those who cut fixed costs early and deeply. I want to see large-scale layoffs and I want to see them now (preferably without severance if contracts so permit - that cash is going to be needed later). Because the reality is that the S&P 500 might not have much at all in the way of 2009 earnings. Most of what earnings there are will likely come from banks, and those "earnings" will be the result of government handouts and inflationary policies only. My earnings targets are $25 in 2009 and $35 in 2010. P/Es will rise all the way to the October 2009 panic bottom, at which they'll probably be around 25, then fall as earnings stage a recovery on the back of inflationary pressures. At this point things could go one of two ways.

    In the best case, things slowly return to normal as the Fed takes trillions of dollars out of circulation in a matter of weeks. CPI increases top out around 10% and then slowly drop. Earnings rise rapidly and then taper off as companies with weak balance sheets are caught off guard by rising input costs.

    In the worst case, as euphoria over the end of the deflationary environment gives way to a second round of panic over runaway prices in 2011, P/Es will drop to their 1970s lows and perhaps further to around 5. We'll finally get our bull-market collapse in Treasuries - it'll make RSX's chart look like a gentle decline - and we'll see the dollar fall against gold to levels that price housing and real estate near historical norms (median SFH around 150 oz +/- 30%, implying that the dollar needs to fall around 60% from present levels). A real recovery will begin only after the 2012 election sees a desperate nation realize its earlier mistake and turn to Ron Paul. Or not, in which case Zimbabwe here we come and earnings mean nothing.
    Reply | Link to Comment
  •  
    Oct 25 03:57 PM
    The overwhelming bearish comments here confirms AAII sentiment data, which is far more bearish now than at any time. That is bullish. However, only the strongest financially deserve investment. The weak ones may not survive.
    Reply | Link to Comment
  •  
    Oct 25 09:05 PM
    News flash for basehitz: posts have been overwhelmingly bearish for months. That's why it's called a bear market. The bear market will end when the imbalances that led up to it have reverted to the mean. Not before, no matter how high your bearish sentiment indicators go. The imbalance, of course, was in the supply of cheap money, and its expression was in housing prices. When they retreat to their historical mean (around 150 oz gold for the median SFH) we'll be close to a bottom. That means either house prices or the dollar need to fall by about 60% from here.
    Reply | Link to Comment
  •  
    Oct 25 10:22 PM
    Bearfund - well said. You a mutual fund guy? I've owned Prudent Bear Fund (BEARX) for a while, and added some Grizzly bear fund GRZZX last month.

    Basehitz - keep in mind that SeekingAlpha and other sites do NOT reflect your average investor.

    Every non-financial-junkie I talk to keeps repeating the mantra of "just hold on through times like these, my financial advisor told me this is actually the best time to buy!"

    The vast, vast majority of America and the world still have no idea about the true scale of the crisis. Most of them stocks are cheap now, but it's just everyone getting scared and selling in a panic. Scared is right, but scared about earnings that are likely to nosedive.

    I'm not covering or buying anything until I see some convincing signs that things are actually improving. "Stocks are cheap" doesn't do it for me. Bear markets (or depressions) usually overshoot to the downside. I don't think we're even at fair value yet, let alone have we overshot to the downside.
    Reply | Link to Comment
  •  
    Oct 25 10:55 PM
    Greg, there is at least some good news in all this. First of all, before all of this is over, you will actually learned something about what a depression feels like because you clearly have no clue today. Second, you will likely lose a few pounds because a reduction in food quality and quantity is on its way to all of America.
    Reply | Link to Comment
  •  
    Oct 25 10:58 PM
    USPIX, URPIX and UVPIX are all superior to both GRZZX and BEARX IMO.
    Reply | Link to Comment
  •  
    Oct 26 12:26 AM
    I believe people are vastly over-reacting. I do not know much about credit default swaps and I suppose financials still have risk. But, many basic industries are trashed, too. For example, I own ARLP. It pays 9% dividend, its pe is about 10. I mines coal for the utilities. Its business is mostly in longterm contracts. Are we going to stop using electricity? I don't think so. Yet, it has gotten trashed.

    Major oil has gotten trashed. BP is paying, what 8% and has a pe of less then 6. Every time majors have approached that, they have been excellent buys. We going to stop using oil? and, do you really think the price is going to stay at $65/bbl?
    Reply | Link to Comment
  •  
    Oct 26 04:15 AM
    epeon,

    Your ignorance about the interconnnectivity of finance to business will be your undoing. You will not listen to what you are about to read today, I know that. But later on, after it comes true, perhaps you will think back on this and try to consider how I could predict what was going to happen to ARLP. Nobody should know this unless there is rhyme and reason instead of the randomness you currently believe rules the day. So here goes.

    ARLP is getting ready for a major plunge. You are only a week or 2 away from this. Today is 10-26-08 and ARLP closed at ~29 this past Friday. My target price for ARLP within 6 months is $8 and it could very well trade down lower. $8 is simply my safe shorting price for this stock. Also, they will cut the dividend to zero within a year, probably much sooner.

    Again, it will not help to explain how I know all of this to you because you will not believe anything that isn't bullish for stocks. That's because bullish markets have been the order of the day for your entire life.

    Get ready for a new life's experience.
    Reply | Link to Comment
  •  
    Oct 27 02:22 AM
    I appreciate all the comments on this post.

    The bears make a good point when they say that we're already in a stock market crash. I should have used the word "collapse" to make my point.

    I also think the comments here provide a valuable read on sentiment. I agree with basehitz:

    "The overwhelming bearish comments here confirms AAII sentiment data, which is far more bearish now than at any time. That is bullish. However, only the strongest financially deserve investment. The weak ones may not survive."
    Reply | Link to Comment
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