Peter Berezin from BCA Research holds a distinctive position amidst 30 analysts, holding the lowest year-end target on the S&P 500 that is tracked by Bloomberg. While his target is 16 per cent below current levels at 5,300, Berezin is no permanent pessimist, often tilting his stance based on incoming data. During 2023, when the consensus forecast predicted a US recession, he had an upbeat outlook, dispelling recession forecasts for that year and anticipating an immaculate disinflation instead, something which he was proven correct about.
As US markets continue to impress with their robust perseverance, we turn our attention to the current state of US markets and their macroeconomic conditions, alongside Berezin’s tempered outlook. How worried is Berezin about a potential US recession this year, and is his lower S&P 500 target a reflection of this prediction? Yes, the 5,300 target is an amalgam of price targets in two possible scenarios.
The first circumstance is one where the US plunges into recession this year, assigned a probability of 60 per cent. In such a scenario, the estimated EPS for the S&P 500 drops to $250 for the year. These estimates are gradually lowering, making a weaker growth scenario with an EPS of 250 entirely plausible. A multiplier of 18 is then applied to that 250, resulting in a price target of 4,500, should a recession unfold.
However, Berezin doesn’t see recession as a certainty, instead potentially avoidable. If a recession is averted, Berezin anticipates the S&P 500 rising to approximately 6,500, with EPS reaching around 265. This results in a weighted average price target of 5,300, hinged on the 60-40 per cent probability division.
Berezin believes that a recession is more probable than not by year’s end, which could see the S&P 500 sinking to nearly 4,500. The 18 times multiple assigned to the S&P 500 in a recession event may seem high, especially from a historical crisis scenario perspective. It is indeed valid to consider that in a milder recession, PE multiples typically drop into the teens, and it’s not unusual for a severe recession to slash PE multiples to single digits.
However, the rationale behind this higher PE multiple is twofold. Firstly, Berezin doesn’t believe the recession, if it occurs, will be overly severe. He sees no major imbalances within the economy – the private sector isn’t over-leveraged, banking balances are solid, and housing oversupply isn’t as significant as it was back in 2007, which intimates a milder recession with a minor impact on earnings.
Secondly, the PE multiple could be justified by an ongoing boom in Artificial Intelligence. Berezin predicts improved productivity data in coming years which, if realized, would definitely validate a higher PE multiple for the equity market. But are there any risk scenarios that might lead to more significant PE multiple contraction, or potential outliers?
One substantial outlier resides in the corridors of the White House. It’s conceivable that a scenario might occur where, for instance, the European Union doesn’t secure a deal with Trump, which could destabilize markets. Should this occur, the EU might feel politically compelled to retaliate, even if this is contrary to their economic best interests. This, in turn, might prompt further tariff increases from Trump, potentially leading to a comprehensive breakdown in Atlantic trade.
Conventional wisdom suggests that Trump would back down at some stage. However, the economic harm these sorts of disruptions cause won’t immediately show up in the data but could undoubtedly pose a risk later. Reduced confidence, decreased spending, and potential triggers for a more significant recession than initially expected emphasize the importance of factoring in the likelihood of an uncontrolled trade war.
Another concern is the state of the bond markets. The US currently faces a nearly 7 per cent GDP budget deficit, all while maintaining a historically low unemployment rate of 4.1 per cent. To have such a sizeable budget deficit in a full employment economy is unprecedented. If a mild recession arises, there will be an automatic escalation in social program spending given the increased number of beneficiaries. Meanwhile, tax revenues would slow, possibly escalating the budget deficit to 8-9, or maybe even 10 per cent.
In a standard recession, bond yields normally decrease, offering a safety net for the economy. However, if the budget deficit approaches 10 per cent of GDP with no foreseeable decline, bond yields might not decrease as expected, exacerbating the economic impact during a typical recession. This potential outcome on the fiscal side is significantly concerning, especially coupled with potential trade complications.
The effects of these potential shocks could be worsened if their occurrences simultaneously coincide. Even in the event that the Federal Reserve reduces rates, a term premium increase might nullify any benefits derived from lower short-term rates. Such a situation is not particularly probable, but the risk should not be overlooked.
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