Had enough? S&P plunge could deepen if recession takes hold

Traders work on the floor at the New York Stock Exchange in New York, Tuesday, Oct. 4, 2022. If the economy really is headed for a recession, the stock market may have still more to drop. (AP Photo/Seth Wenig, File)

NEW YORK (AP) — If the economy really is headed for a recession, the stock market may have still more to drop.

The S&P 500 came into this week having already plunged roughly 24% from its record high earlier this year. But history shows the average U.S. recession since 1947 has brought an even bigger fall for stocks: roughly 30%, according to Goldman Sachs.

Recently, the pain has been even worse than that. The last three recessions have seen the main measure of the U.S. stock market lose between 34% and 57%.

How stocks behave around recessions isn't an academic question. With the Federal Reserve hiking interest rates sharply in hopes of getting inflation under control, more economists are warning of a possible downturn.

The housing industry has already been hit hard by the leap in mortgage rates that have resulted from the Fed's moves. Sales of new homes sank in the summer to their weakest level in more than six years. Growth has slowed elsewhere in the economy too. Manufacturing is expanding at its weakest pace since the 2020 recession.

The jobs market is still doing well and unemployment is very low, as employers continue to hire hundreds of thousands of workers every month. That's actually discouraging to Wall Street, believe it or not.

The good news for wage earners will likely spur the Fed to aggressively hike interest rates further, and keep them there longer. Higher interest rates will slow the economy by making it more expensive to get a loan to buy a house, a car or anything else on credit.

High rates also hit the two main levers that set stock prices. On one hand, they can drag down corporate profits by making borrowing more expensive, and lower sales through a weaker economy.

On the other hand, high rates change stock investors' risk-reward calculation: Investors can get relatively better returns by buying safe bonds, which draws money away from riskier stocks.

Strategists at Goldman Sachs say the S&P 500 could ultimately fall 34% from its peak if investors become convinced a “hard landing” is coming for the economy. In that scenario, the S&P 500 could fall to 3,150 by the middle of next year. It closed Tuesday at 3,588.84.

Strategists at Deutsche Bank are even more pessimistic. They say stocks looked particularly expensive coming into this year, with one measure of valuation at its highest level on record outside the tech bubble at the turn of the millennium. The German bank says the S&P 500 could fall to early-pandemic levels around 3,000, if profits drop by the usual amount for a recession.