Stocks slumped this week after Federal Reserve Chair Jerome Powell warned Americans about the possibility of a “prolonged recession.”
While that phrase may sound pretty scary to investors, Sevens Report’s Tom Essaye said Thursday stock prices may hold up much better in 2020 than during the previous two extended U.S. recessions.
During the U.S. recession in 2001-2002, the S&P 500 dropped by more than 30%. During the recession in 2009-2010, the S&P fell 50%. However, Essay said there is one key difference between the current situation and the previous two recessions, and that factor is the Federal Reserve.
From September 2008 to September 2014, the Fed’s balance sheet increased from $1 trillion to $4.5 trillion. In March and April of 2020 alone, the Fed expanded its balance sheet from $4.1 trillion to $6.7 trillion.
“That’s $2.6 billion in two months, compared to $3.5 trillion in six years!” Essaye said. “And, the Fed isn’t done, either, as the balance sheet will certainly eclipse $7 trillion soon.”
Don’t Fight The Fed
Essaye isn't predicting the Fed has prevented a bear market or that stock market volatility won’t lead to another correction in the near future.
“Point being, this is very, very powerful support for stocks, and the net effect is that it should be able to offset a lot of the negatives from even a ‘prolonged recession,’ at least from a stock market standpoint, because the liquidity has to go somewhere,” Essaye said.
For now, given the unprecedented stimulus, Essaye said applying a 16-17 times multiple on $155 in 2020 S&P 500 earnings yields 2,558 as a downside target for the S&P 500, suggesting the March low could be the bottom.
“We remain comfortable with that level being a reasonable floor in this market unless we get a resurgence of the virus (that causes another national lockdown) or the Fed begins to hedge on support,” Essaye said.
Given the potential valuation floor at 2,550, Essaye sees current fair value for the S&P in the 2,800 to 2,900 range, which is right where it's trading today.
The 26.7% rally in the SPDR S&P 500 ETF Trust (NYSE: SPY) since March 23 may seem overly optimistic given COVID-19 is still ravaging the economy. However, investors shouldn’t overlook the aggressive Fed stimulus or the fact that the S&P 500 was down more than 30% at one point this year and remains down 12% year to date.
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