How bad can it get if US falls into recession?

Associated Press

NEW YORK

Are investors overreacting to the prospect of a recession?

The slightly better jobs report Friday notwithstanding, the odds of a recession appear to be climbing, and that’s bringing back scary memories. Though stocks may look cheap thanks to record corporate profits, that was also true the last time the U.S. was heading into a downturn. Based on recent recessions, profits could fall a third if the economy crumbles.

Investors have been worried about a new recession for months. Headlines last week ratcheted up the fear.

On Tuesday, the Federal Reserve Chairman Ben Bernanke testified to Congress that the recovery is “close to faltering.” Goldman Sachs said Europe could fall into recession by the end of the year, and push the U.S. “to the edge” of one itself. A co-founder of the Economic Cycle Research Institute, a forecasting firm that called the last three downturns, made the rounds of TV news shows to say a U.S. recession was all but inevitable.

With memories of the Great Recession so fresh, investors are understandably spooked. A year after that downturn began in Dec. 2007, profits at companies in the Standard & Poor’s 500 index turned into losses. Three months after that, stocks hit bottom at half their pre-recession peak.

But recessions come in many varieties, and most are less scary than the last one. Problem is, not even experts who study downturns can predict exactly what kind of recession may come next.

Most Wall Street analysts and economists think one isn’t even likely now. Jim Paulsen, chief investment strategist at Wells Capital Management, notes that recessions are typically preceded by what he calls “excesses” that need to be purged from the economy. He doesn’t think that’s true today.

How likely is a repeat?

Banks have fatter cushions against losses now than before the financial crisis. Companies in the S&P 500 are making more money than ever, and squirreling away some as cash reserves, a sort of rainy-day fund. They’ve laid off so much staff and are running so lean, it won’t be as easy to cut jobs like they did in the last recession.

So if a recession is coming, how bad might it get? That depends on whether the U.S. falls into one alone or together with other countries as it did the last time.