The S&P 500 is precariously close its 52-week low. If it breaks below that number, how much further might it fall? Recent history suggests the possibility of a long drop.
The S&P index is trading at 1,136, against a 52-week high of $1,371 and a low of $1,102. It topped $1,353 just a little over two months ago. Since then, stocks have sunk due to concerns about the possibility of a new recession and worries about a collapse of the debt markets in some of the eurozone's most economically fragile nations.
A return to recession appears more likely by the day. U.S. consumer confidence is near lows last seen two years ago. Last week, stock markets dropped the most they have, on a weekly basis, since 2008. Unemployment numbers have barely improved over the past three months. And the the housing market shows no signs of improvement. Some economists believe prices won't recover in certain markets for years.
Since the stock market hit its cyclic nadir in spring 2009, the backbone of its long rally has been strengthening corporate earnings. Those gains were driven in large measure by cost cutting. Sales have been slow to recover because there has been no strong economic recovery in the U.S., but productivity has increased sharply as companies figure out how to get more from each worker. Yet cost cutting can only go so far, and that trend is faltering after nearly four years of downsizing. While many employers may not cut more jobs, they aren't hiring much either. Companies want to wait and see whether they can afford new workers. And President Obama's tax credits for hiring won't help much if firms think a new downturn is near, because a tax break can't offset the sales drops that will occur if the economy slows sharply again, or begins to contract.
The question of whether a slowdown has severely damaged corporate revenue will begin to be answered as companies announce third-quarter earnings and offer guidance for the final quarter of the year. Weak numbers would provide another reason to sell stocks after the sharp declines of the past month.
The last sharp market dip took the S&P 500 below 683 in March 2009. If the stocks were to drop that far again, it would be a reset of another 40%. That's unlikely. The sell-off that ended in spring 2009 was relatively rapid, based on the U.S. credit crisis and the realization that the U.S. economy was in its greatest recession in the better part of a century. But the S&P was only below 800 for a quarter, and recovered to that level by April 2009 as investors saw that the banking crisis had ended.
A near-collapse of the credit system with the next recession is unlikely. Banks have buttressed their balance sheets, and most of the largest financial firms say they have only modest exposure to EU sovereign debt. Still, that leaves the current economic slowdown, which is more than enough to drag us into the second dip of a double-dip recession. If it does, stocks have another 25% to fall.