Based on history, the stock market is pricing in a recession and maybe something more 'onerous'

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A grizzly bear roams through the Hayden Valley in Yellowstone National Park in Wyoming.

Jim Urquhart | Reuters

The market’s blistering sell-off over the last month is so bad that investors have already pretty much priced U.S. stocks as if the economy is headed for a recession, based on a history of past declines around economic downturns by RBC.

The median and average recession-related market decline sees the S&P 500 plunge 24% and 32%, peak to trough, respectively, RBC research shows. And with the broad index already down about 28% from its record close in February, it looks like investors think the U.S. is headed for a significant downturn in economic output.

The blue-chip, 30-stock Dow Jones Industrial Average is more than 29% off its own record close.

“At Thursday’s low of 2,481, the S&P 500 was down 27% from peak, telling us that stocks have started to bake in recession,” wrote RBC Head of U.S. Equity Strategy Lori Calvasina. “A 32% drop would take the [S&P 500] to ~2,300, below its December 2018 low of 2,351. We expect that level to be tested.”

But Calvasina warned that even though investors already seem to be pricing in a recession, something “more onerous” could be ahead for investors if the market breaks through that 2,300 level.

“We think it is extremely important to listen to what the stock market is trying to tell us over the next few days. If the S&P 500 breaks below 2,300, we think it will be signaling that stocks are anticipating something more severe than a recession,” she wrote. The S&P 500 was around 2,500 midday Monday.

The strategist said that a small group of investors are still hopeful that the bear market will be short-lived or quickly bounce back, a fact that could mean the market may have further room to fall.

“Sentiment still has room to deteriorate,” Calvasina wrote. “Even before the futures went limit down Sunday night, the sentiment data was telling us that it was still premature to call a bottom in the S&P 500 or an end to the stock market’s recent bout of extreme volatility.”

“If the S&P 500 falls meaningfully below 2,300, it will signal to us that stocks are starting to bake in something more onerous,” she added.

 The major indexes fell more than 10% on Monday within the first minutes of trading, triggering a Level 1 circuit breaker that halted trading for 15 minutes.

Before Monday’s moves, the Dow and the S&P 500 were down more than 20% from their respective intraday records hit in February.

Monday’s sell-off came even after the Federal Reserve on Sunday announced a historic and massive monetary stimulus campaign to curb slower economic growth amid the coronavirus outbreak. The central bank said it will slash U.S. interest rates to zero and launch a $700 billion quantitative easing program to shelter the economy from the effects of the virus.

Despite one of the most expansive moves in the history of U.S. monetary policy, equity traders were left nervous about the coronavirus and efforts to contain its spread, which some fear could tip the economy into a recession.

“It’s possible that a retest could come as early as Monday, March 16, given that the futures went limit down on Sunday evening after the Fed’s extraordinary moves were announced,” Calvasina wrote.

CNBC’s Nate Rattner and Michael Bloom contributed reporting.

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