By Jack Hough

Some Wall Street firms like to issue price targets in sets of three: their bull, bear, and base cases. When did stock market forecasting become one of those Choose Your Own Adventure paperbacks from grade school? Because those usually ended with me being overrun by hairy spiders, or drowned in a submarine, or zapped by a freeze ray and then labeled Human Meat Galactic Prime. No wonder I became more of an index investor.

My main complaint about price tri-targets is that bearish outcomes often seem lacking in grisly imagination. The global strategy team at J.P. Morgan puts the bear case for the S&P 500 index at 4000 by year's end, based on underlying earnings per share of $250 next year, and a forward price/earnings ratio of 16. This scenario, published two days before the White House announced a temporary pause for its new schedule of punishing worldwide tariffs, assumes that trade upheaval results in only minimal earnings growth from last year's $240 level.

Back in November, just after Election Day, the S&P 500 first topped 6000, so a drop now to 4000 would be painful, true enough. But it would still mark a nine-year doubling -- hardly the equivalent, on a Choose Your Own Adventure scale, of being dropped into an active volcano, or strangled with bedsheets.

Likewise, negligible earnings growth over two years would be disappointing relative to the 27% growth implied by the current consensus estimate. But is that a worst-case outcome? Stock strategists at BofA Securities wrote that the now-paused tariffs would have taken S&P 500 earnings down by 5% to 35%. The wide range reflects the unknowable aftereffects of rising prices and overseas retaliation.

So long as I'm quibbling: The S&P 500 was trading near 23 times earnings before this year's downturn, which makes a decline to 16 sounds severe. But is it, or is our perception warped by what behavioral psychologists call recency bias -- the tendency to overestimate the importance of the latest outcomes when estimating future ones? Back in 2000, an economist at the Kansas City Fed looked at 128 years of stock data and found that the average trailing P/E ratio was 14.5.

Some stock prognosticators and math fetishists call this a "declining equity risk premium." We're all willing to pay more for stocks than we used to, the thinking goes, perhaps because we've come to expect policymakers to swoop in with a fix during downturns. Maybe the old-timey numbers are no longer relevant. Or maybe things have just been puffed up for decades, a few big wobbles notwithstanding, by rising global trade, low U.S. prices and interest rates, swelling corporate profits, and a flood of capital into U.S. assets. Give me 30 more years to think about it and I'll tell you which camp I'm in.

Meanwhile, if I assume a 10% earnings decline, and apply what used to be an ordinary P/E ratio of 14.5, I come up with an S&P 500 level of 3132. That would leave the market down 47% for the year, far worse than the 15% or so it was recently down. The point here isn't that I think this will happen. It's that bear cases, to me, are meant for reasonably preparing for outcomes that are much worse than what you expect. Technical analysts at Oppenheimer wrote recently that the S&P 500 is close to a "high-intensity low," and that "bear-cycle thresholds" are 4800 over five to seven months in the event of a short and sharp downturn, or 5100 over nine to 12 months with a long and shallow one. I'd love to believe that's the downside, but I'm registering a high-intensity don't-know.

Corrections are more normal than you might think, says Francis Kinniry, head of investment at Vanguard's Advisory Research Center. Since 1980, the market has traded 10% or more below its high some 30% of the time. Investors are best off staying the course with a mix of U.S. and overseas stocks, plus high-quality bonds, says Kinniry. David Steinbach, global chief investment officer at Hines, which manages $90 billion in real estate, is optimistic, too, but says that for investors, higher trade friction will be like shifting from downhill to cross-country skiing. At my fitness level, the active volcano plunge sounds more appealing, but OK.

There were some mixed signals about what led to the tariff pause. The White House press secretary said the media had missed the "art of the deal," and that more than 75 countries had called to negotiate. But the announcement coincided with a selloff in the bond market, and President Donald Trump said that people had been "getting a little bit yippy." Immediately afterward, stocks ripped higher, but the damage isn't all undone, according to Bhanu Baweja, chief strategist at UBS. Assuming the temporary 10% global-tariff rate holds, and the rate on China is negotiated down to 50% from 104%, the hit to U.S. demand will be enough to bring earnings growth down to a low-single-digit percentage, and possibly zero, he estimates. If that's the base case, here's hoping we can avoid the bear case.

Speaking of which, I saw a chart on a data visualization blog mapping more than 100 possible plot paths for one of those Choose Your Own Adventure books. It showed that readers are about 10 times as likely to reach an unhappy ending as a happy one, so maybe it wasn't just me. I guess the macabre twists are more fun. Out of nostalgic curiosity, I popped into my little town's library and asked if they had any of the books. The librarian led me to three. "Funny thing," she said. "You're the second person asking about these this week." Maybe Wall Street strategists have been poking around for inspiration.

Write to Jack Hough at jack.hough@barrons.com. Follow him on X and subscribe to his Barron's Streetwise podcast.

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April 11, 2025 02:00 ET (06:00 GMT)

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