With a Recession Incoming, How Much Lower Can the Market Go?

So, if we’re asking how low the market can go, we have to assume that a recession will happen and go from there.

Historically, during the 1989-1991 recession, earnings dropped around 25%. During the 2001 recession, earnings dipped 30%. And during 2008’s deep recession, earnings fell around 60%.

So logically, if we hit a deep recession, we can expect around a 60% drop in earnings. But if we see a shallow one, like the ones in 1989 and 2001, we can expect 30% earnings dip.

Right now, it’s very unlikely that we get a deep recession. Household and consumer spending is strong, as is corporation spending. And the labor market is too strong. We’re only at 3.4% unemployment, and even a 5% unemployment rate would still be OK. We were seeing an 11% to 12% drop during 2008’s deep downturn.

Even if this quarter was the peak before the downturn, stocks would not drop 30% like earnings.

Earnings compression is offset by multiple expansion for two reasons. First, during recessionary times, long-term treasury yields go lower. That provides room for stocks to go lower. Secondly, as earnings go lower, investors will pay a premium. That’s because stocks only have room to go higher.

The math supports the thesis that the odds of a shallow recession outweigh the odds of a deep one.

It also shows that the S&P 500 is either fairly valued or undervalued today. And that means it’s a good time to start dip-buying.

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