by Tim Murray – Capital Markets Strategist, Multi‑Asset Division
Deepening recession concerns have caused stocks to sell off precipitously in 2022, and major indexes recently reached bear market territory—meaning that they had fallen at least 20% from their recent highs. An in‑depth look at the sell‑off reveals that it has primarily been driven by a decrease in price‑to‑earnings (P/E) multiples (Figure 1).
Anatomy of the 2022 Sell‑Off
(Fig. 1) The price‑to‑earnings (P/E) ratio of the S&P 500 has declined, but forward earnings estimates remain overly optimistic
January 1, 2019, to July 18, 2022.
Source: S&P. T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. See Additional Disclosures. Bloomberg Finance, L.P. Past performance is not a reliable indicator of future performance. Actual outcomes may differ materially from estimates. Estimates are subject to change.
Although some investors may conclude that stock valuations have now become reasonable, it is important to note that, despite numerous signs of looming economic weakness, earnings estimates have not adjusted downward this year. So far in 2022, the 12‑month forward earnings estimates have, in fact, risen by 4%. Therefore, while the current P/E ratio seems attractive, it is based on a very optimistic outlook for company earnings.
For investors evaluating the current market environment, a review of historical data showing how earnings estimates have behaved during past recessions can be informative. Notably, an analysis of earnings estimates for companies listed on the S&P 500 Index since 1990 shows that during each of the past four recessions, earnings estimates fell sharply, with an average drop of 22% (Figure 2).
How Far Could Earnings Estimates Fall?
(Fig. 2) Earnings estimates have fallen meaningfully during past recessions
January 1990 to June 2022.
Sources: T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. See Additional Disclosures. Bloomberg Finance, L.P. Actual outcomes may differ materially from estimates. Estimates are subject to change.
Overall, stock prices seem more reasonably priced relative to their peaks early in the year. However, in our view, a recessionary scenario may not be fully baked in to the current share prices because earnings expectations remain too optimistic. As a result, our outlook remains cautious, and our Asset Allocation Committee maintained an underweight allocation to stocks relative to bonds.
Additional Disclosures
The S&P 500 Index is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”) and has been licensed for use by T. Rowe Price. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); T. Rowe Price is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, or their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index.
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