A Severe Recession Is Now Priced Into Stocks

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 reported a 9% decrease in global sales volumes 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.  Dow, for example, is trading for about 8 times this year’s earnings.  Even if earnings drop by 25% in 2009, this is not an expensive stock.

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 (870).  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 collapse or depression, now is a time to buy stocks.