A '70s style recession would push S&P 500 to 2,525 – SocGen

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A recession is 74% priced into stocks and there is a remote chance economic conditions could push the S&P 500 (SP500) (NYSEARCA:SPY) more than 1,000 points lower, Societe Generale says.

Fair value of the S&P based on earnings remains at 3,850, but a couple more dominoes need to fall before the market sees a “true bottom,” Manish Kabra, SocGen head of U.S. equities, wrote in a note Tuesday.

Those dominoes will be credit and housing markets pricing in higher recession fears, Kabra said.

“The current 24% drop in equities suggests we have discounted 72% of an average recession (i.e. a 72% recession probability is priced in),” he said. “At 3200 the S&P 500 will fully discount a typical recession.”

“An average recession that would be more destruction-focused that typically helps to clear out extreme inflation and excesses.”

“The question that is emerging in the current cycle is whether inflation will fail to mean-revert despite the downturn in the cycle (discussed further in the commodity section),” Kabra added. “The 1970s experience still looks extreme given the current extremely tight labor market. However, the most important read-across from the 1970s is that when the market starts to believe that inflation will remain high for longer, equities start to focus on ‘real EPS’ and not nominal.”

“For instance, our 5% 2022 EPS growth forecast is less than the inflation rate of c.8%, implying we are likely to see negative real EPS in ‘22,” he said. “If such negative real EPS backdrop persists, a tail-risk scenario of a 1970s-style recession would put the S&P 500 at 2525 (stagnation with higher inflation = S&P 500 trades on a lower multiple).”

That would be a 33% drop from current levels.

SocGen screened for a Stagflation Stock Basket, looking for stocks with score highly on defensive style characteristics – for example, stocks that perform in a ‘recession’ phase of the economic cycle.”

The stocks – with recession score (100 = high, 1 = low) and revenue correction to inflation – are:

  1. 3M (MMM), recession score 91, revenue correlation to inflation 0.5
  2. Archer-Daniels-Midland (ADM), 90, 0.6
  3. Chevron (CVX), 95, 0.8
  4. Cisco Systems (CSCO), 99, 0.5
  5. Coca-Cola (KO), 91, 0.4
  6. Colgate-Palmolive (CL), 96, 0.6
  7. ConocoPhillips (COP), 82, 0.7
  8. Consolidated Edison (ED), 85, 0.5
  9. Corteva (CTVA), 75, 0.6
  10. CSX (CSX), 83, 0.7
  11. Danaher (DHR), 78, 0.5
  12. DTE Energy (DTE), 84, 0.4
  13. Edison International (EIX), 75, 0.4
  14. EOG Resources (EOG), 79, 0.7
  15. Exxon Mobil (XOM), 94, 0.9
  16. Genuine Parts (GPC), 85, 0.5
  17. Honeywell (HON), 83, 0.6
  18. Illinois Tool Works (ITW), 87, 0.6
  19. Johnson & Johnson (JNJ), 97, 0.5
  20. McDonald’s (MCD), 91, 0.6
  21. Microsoft (MSFT), 93, 0.5
  22. Occidental Petroleum (OXY), 82, 0.8
  23. Philip Morris International (PM), 100, 0.7
  24. Phillips 66 (PSX), 79, 0.9
  25. Procter & Gamble (PG), 98, 0.6
  26. Sempra Energy (SRE), 89, 0.5
  27. Starbucks (SBUX), 93, 0.4
  28. Stryker (SYK), 86, 0.5
  29. Union Pacific (UNP), 80, 0.7
  30. Visa (V), 85, 0.5
  31. Walmart (WMT), 99, 0.4
  32. Waste Management (WM), 79, 0.7

Today, Morgan Stanley picked top stocks for a risky environment.