BNP Paribas has studied 100 years of market crashes – here’s what’s next

Oops. Stocks fell through key support on Tuesday and it looks like recent momentum has now faded. The new line in the sand for the S&P 500 SPX,
seems to be 3,900. Whether or not Santa will eventually arrive has yet to be determined, with Mr. Claus potentially 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 analyzed 100 years of crashes to see what comes next.

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

The recent crash – the COVID-19 slump in March 2020 – is a bad pattern, in their view, as it was caused by both the extreme nature of the economic shutdowns and rapid monetary and fiscal policy responses. They also don’t expect 2008 to be the model, as they expect US GDP to contract about 1% next year and earnings per share to fall 1.5%.

However, 2002 is fairly representative of recessionary crashes. This bear market lasted more than two years, with a 50% drawdown and a 29 percent point peak-to-bottom move in the VIX VIX,
A typical recession bear market lasts 1.5 years, with a median drawdown of 38% and a median top in the VIX of 40.5.

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

The bull market that ended last year was similar to that of the 1990s, with heavy retail participation, massive P/E appreciation and many of the top performers being unprofitable. The S&P 500 bottomed out 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 price-to-earnings ratio falls to 14.

In a neat analysis, BNP recreated the VIX VIX,
which CBOE introduced in 1993 to cover the last 100 years. Typically, volatility peaks at or before the market bottom.

“We view a capitulation as a move associated with a sense of panic that includes a rebalancing of expectations, analysts aggressively trimming forecasts, volatility spikes and tails re-evaluation. Over the past 100 years, volatility capitulations have come, on average, at the same time as the market bottom,” they say.

What do you like about such a market? One idea is to find companies that have sustained share buybacks during a slowdown. Another possibility is to look at companies with earnings momentum, although the only sector identified on a related chart with positive momentum is Utilities XLU,
Tech is still vulnerable, although what it calls prime tech could outperform more speculative and cyclical parts of the sector.

The market

After Tuesday’s plunge, US stock futures ES00,

edged lower. Oil futures CL.1,
fell, and the 10-year yield TMUBMUSD10Y,
was 3.54%. The inversion between the 2-year and 10-year rates is now at levels last seen since the 1980s.

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