BNP Paribas has studied 100 years of stock market crashes - here's what it says is to come

BNP Paribas has studied 100 years of stock market crashes – here’s what it says is to come

Oops. Stocks fell through key support on Tuesday and it looks like some recent momentum has now run out. The new line in the sand for the S&P 500 SPX
appears to be 3,900. Whether or not Santa Claus will eventually come remains to be determined, with Mr Claus possibly postponing a decision until next Tuesday’s CPI release.

But what is clear is that the US stock market is still in a bear market. And with that in mind, BNP Paribas equity strategists have exploited 100 years of crashes to try to determine what’s next.

Strategists led by Greg Boutle, head of US equity and derivatives strategy, expect a sellout next year. “It would be a break from the current bear market regime, which has been characterized by stocks falling as P/E multiples have contracted,” they say.

The most recent crash – the March 2020 COVID-19 crisis – is a bad model in their eyes, as it was driven both by the extreme nature of the economic shutdowns and the rapid monetary and fiscal responses. They also don’t expect 2008 to be the model, as they see US GDP contracting about 1% next year and earnings per share falling 1.5%.

However, 2002 is fairly representative of recessionary crashes. This bear market lasted more than two years, with a 50% decline and a peak-to-trough movement of 29 percentage points in the VIX VIX.
A typical recessionary bear market lasts 1.5 years, with a median decline of 38% and a median peak in the VIX of 40.5.

“If we apply these averages to the market today, it implies a bottom in the middle of next year, with the S&P bottoming near 3,000, and with the VIX in the low 40s,” they say.

The bull market that ended last year was similar to that of the 1990s, with high retailer participation, massive P/E multiple price expansion and many of the top performers unprofitable. The S&P 500 bottomed in 2002 with a price-to-equity ratio of 14. BNP’s 2024 EPS forecast of $231 implies 3,250 for the S&P 500 if the P-to-E multiple falls to 14.

In a careful analysis, BNP recreated the VIX VIX,
which the CBOE introduced in 1993, to cover the past 100 years. Usually volatility peaks at or before the bottom of the market.

“We view a sellout as a move associated with a sense of panic that involves a rebasing of expectations, analysts aggressively slashing forecasts, rising volatility and repricing of tails. Over the past 100 years, volatility capitulations have on average occurred at the same time as the market bottom,” they say.

What do they like in such a market? One idea is to find companies that have maintained share buybacks during a downturn. Another is to look at companies with earnings momentum, although the only sector identified with positive momentum in a related chart is XLU Utilities..
Technology is still vulnerable, although what it calls cutting-edge technology could outperform the more speculative and cyclical segments of the sector.

The market

After Tuesday’s drop, US stock futures ES00

edged lower. CL Oil Futures
fell, and the 10-year yield BX:TMUBMUSD10Y
was 3.54%. The inversion between the 2-year and the 10-year is now at levels not seen since the 1980s.

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