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S&P 500’s Low May Have Priced in Recession: Technical Analysis

The Standard & Poor’s 500 Index bottomed three times near 1,120 last month and if history of past earnings and valuations is any guide, that level may have priced in an economic recession, LPL Financial Corp. said.

Jeffrey Kleintop, the firm’s chief market strategist in Boston, sees only a 1-in-3 chance for a recession to take place. Even if an economic contraction occurs, stocks will find support at their August lows, he said. Should growth start to pick up, the S&P 500 may rise 15 percent from its Sept. 2 close of 1,173.97 to end the year at about 1,350, he forecast.

“The markets’ obsession with recession does not make it a foregone conclusion,” Kleintop wrote in a report dated Sept. 6. “Investors’ lack of confidence in economic growth, corporate profit forecasts, and the actions of policymakers is likely already fully reflected in the markets and creates the potential for a bounce if any of them exceed low expectations.”

The S&P 500 declined as much as 18 percent from a three-year high on April 29 amid concern about Europe’s debt crisis and signs U.S. growth may be slowing. The benchmark gauge for American stocks surged as much as 102 percent from a 12-year low in March 2009 as earnings beat analysts’ estimates and the Federal Reserve bought Treasuries to boost the economy.

Kleintop found that over the past 50 years, the stock market typically bottomed three to six months before the worst part of a recession. During the downturns since the 1930s, corporate income for the S&P 500 generally fell 12 percent to 24 percent from peak to trough, with price-to-earnings ratios averaging 13.35 at the bottom of a cycle, according to LPL data.

GDP Growth

U.S. gross domestic product grew at an annual pace of 1 percent in the second quarter. Data released last week showed the U.S. unemployment rate remained stuck at 9.1 percent in August and payrolls unexpectedly failed to grow, while confidence among consumers plunged to the lowest level in more than two years.

Should the economy enter a recession, the earnings pullback will be at the lower end of the historic range partly because American companies are counting more on developing countries for growth, Kleintop said. S&P 500 profits totaled around $95 a share in the past four quarters and a 12 percent decline would suggest an annual income of around $84 a share, he estimated.

A much worse-than-expected recession could drive earnings down 22 percent to around $74 a share and push the S&P 500 to 1,000, he said, adding that he sees that event at “a very low, but not zero, probability.”

“It seems that the debate over whether a recession will take place has now been settled for many investors and they have moved on to whether the recession will be much worse than average,” Kleintop wrote. “We see more upside than downside to the stock market.”

The S&P 500 fell to this year’s low of 1,119.46 on Aug. 8 and closed at 1,120.76 two days later before rebounding. On Aug. 19, the benchmark halted a two-day decline at 1,123.53 and has since climbed 6.7 percent.

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