S&P 500 Index could fall 15-20% if the economy enters a full-blown recession – UBS

S&P 500 wrapped up the second week of 2023 with another positive performance. But economists at UBS think that the upcoming 4Q corporate reporting season will provide a reality check.

4Q earnings growth to stall

“Earnings headwinds – an aggressive Fed, a normalization in demand for goods popular during the pandemic, a stronger USD, and higher costs because of more expensive labor – have become strong enough for us to expect no growth in S&P 500 4Q earnings per share compared to the same period last year. Overall, we expect a sharp slowdown in revenue growth to the 4-5% range, and a continued normalization in profit margins from higher-than-average levels last year.”

“Our view on full-year 2023 earnings remains unchanged. Our 2023 EPS estimate is USD215, which is a 4% decline from 2022. We believe the full-year bottom-up consensus EPS estimates look at least 6 percent too high.”

“The S&P 500 forward P/E is at 17.3x compared to the 15-66x range prevailing before the 2Q and 3Q reports. It is also high by historical standards. This suggests that even if results are a bit better than investors expect, the upside market potential may be somewhat limited.”

“Even if the bottom-up EPS estimate of USD230 proves correct, we struggle to justify paying a P/E of more than 18x. That suggests upside potential to 4,140 for S&P 500, only 4% higher than current levels. At the same time, downside risks remain elevated, and stocks could fall 15-20% if the economy enters a full-blown recession.”