The S&P 500 could fall another 23% in a worst-case scenario as the stock market prices in a one-third chance of recession, BofA says
bevans@insider.com (Brian Evans)
The S&P 500 will plunge 11% by the end of 2022 as 'inflation shock' sparks a recession, Bank of America researchers say.
The S&P 500 could tumble to 3,000 in a worst-case scenario, Bank of America said.
On Friday, the index closed at about 3,912, with BofA's estimate representing 23% further downside.
BofA also estimated that a one-third chance of a recession has been priced into the stock market so far.
The S&P 500 is settling into a bear market that could push the index down as far as 3,000 in a worst-case scenario, Bank of America said in a note published Friday.
The broad index closed the week at about 3,912, meaning BofA's estimate represents 23% further downside potential.
Meanwhile, a one-third chance of a recession has been priced into the stock market so far, according to the note, which said relying on the price-to-earnings ratio to predict the S&P 500's performance isn't as reliable as the equity risk premium.
Analysts pointed out that the current bear market is the the 27th since 1929, and historically they have resulted in a 35% average decline. That implies the S&P 500 would bottom at 3,100, largely in line with BofA's worst-case scenario of roughly 3,000 using its equity risk premium framework.
Elon Musk says we're in a recession..
Elon Musk said at a conference Monday he believed the US is probably in a recession.
US GDP shrunk last quarter, and two contractions in a row typically marks a recession.
Wall Street firms are split on the prospect of whether the US will tumble into one.
Americans are feeling the weight of inflation — and the biggest financial firms are at a crossroads about whether that means a recession is coming.
Elon Musk is more certain. At a Miami "All In" tech conference on Monday, the Tesla founder posited that the US is already in a recession that he believes could last anywhere from a year to 18 months.
"Recessions are not necessarily a bad thing," he said via video. "I've been through a few of them. And what tends to happen is if you have a boom that goes on too long, you get a misallocation of capital. It starts raining money on fools, basically."
Musk isn't an expert, but he's joining a chorus of others sounding the alarm on a pending recession — which the National Bureau of Economic Research defines as a widespread, months-long decline in the economy. After all, getting food on the table is more expensive. So is putting gas in the tank. The highest inflation in 40 years has a domino effect on the housing market as well, meaning that buying a home is getting increasingly prohibitive.
This pressure has bled into the most widely monitored measure US economic growth — gross domestic product — which shrank in the first quarter for the first time since the start of the pandemic.
With all that going on, it's difficult for many to feel optimistic about the state of the economy.
"People are noticing the higher prices, and that in many cases, their wages aren't keeping up," Tara Sinclair, an economics professor at George Washington University, told Insider.
Several economists told Insider that current inflationary problems are a bump in the road that low and middle-income Americans are reasonably equipped to withstand, pointing to data that shows Americans' finances are actually keeping up with rising costs. There are also plenty of jobs to go around, with the labor market's recovery holding strong. And Americans are still spending, with the savings they amassed during the pandemic still helping to keep the economy afloat.
All that extra cash is one thing Musk is blaming for the economic downturn.
"The obvious reason for inflation is the government printed a zillion amount of more money than it had," he argued. "The government can't just issue checks for an excessive revenue without there being inflation."
And some financial professionals have painted a dark picture, with multiple large firms forecasting an imminent recession. On the whole, Wall Street is divided.
On one side of the aisle is Bank of America and Deutsche Bank, which say the US is certain to plunge into recession. Opposite them are JPMorgan and UBS, who acknowledge that economic pressures will persist, but don't think a full-on recession is coming.
Forecasts for a recession have grown in recent weeks as experts say the Federal Reserve was too slow to tackle inflation and must now tighten monetary policy abruptly, threatening to snuff out the economic expansion.
But that doesn't mean investors stay on the sidelines. BofA recommended staying long on the energy sector and avoid consumer discretionary stocks, pointing out that energy has outperformed the S&P 500 by 44 percentage points.
Brent crude remains above $100 per barrel and is unlikely to see much downward pressure from a surge in new supply. BofA estimated that capital expenditures among US oil producers as share of operating cash flow has plummeted to a record low of 30%, down from the 2011-2016 range of 80%-100%.
"On the flip side, Consumer Discretionary ranks at the bottom," analysts wrote. "As evidenced by retailers' recent earnings, consumers' shift from discretionary items to necessities poses further risk. Moreover, Energy and Consumer Discretionary earnings have historically been negatively correlated."
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