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The market is failing to price in the likelihood of a recession that would push stocks down by about 30%, according to a study by The Leuthold Group summarized by Bloomberg[1]. Leuthold compared previous highs and lows in S&P 500 valuations based on EPS[2] calculated under GAAP[3] accounting rules. They found that the S&P 500 now trades at roughly 19.4 times earnings, a valuation within the top 10% of historical measurements.

“If we do stumble into recession over the next year, which I think is likely, I think we’ll see below 2,000s on the S&P,” as Doug Ramsey, chief investment officer (CIO)[4] of Leuthold Weeden Capital Management, told Bloomberg. “It’s very easy to get there. We don’t need to assume that you go back to old bear market lows," he added.

The current valuation multiples of 19.4 for the S&P 500 and 24.4 for the Nasdaq 100[5] are reasonable only during economic expansions, especially when interest rates are as low as they are today, Bloomberg observes. When the last 12 bear markets during the past 70 years hit their respective bottoms, the valuation multiple has ranged from 5.6 to 14.4, with the latter figure coming at the low point of the dotcom crash[6].

Harris Kupperman, the president of Praetorian Capital Management and CEO of Mongolian Growth Group, is among those concerned about valuations. "These things literally have no economic rationale to exist [except] for the fact that liquidity[7] has been pushed through the system, and people keep buying shares because they believe that there's some other sucker who's even dumber than they are," Kupperman told Business Insider...

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