If all remains well with the US economy in 2026, investment bank Stifel sees 9% upside ahead for the S&P 500.
However, if a recession materializes, investors should be prepared for a swift 20% drop in the benchmark index, the bank said in a client note on Thursday.
“Fed is easing, but recession risk (with a fast -20% S&P 500 decline) is not trivial,” Barry Bannister, Stifel’s chief US equity strategist, said.
Recession is not Stifel’s — nor any major bank’s — base case scenario for next year. The Federal Reserve also just upped its growth forecast for 2026, and Stifel assigns about a 25% chance that a downturn strikes.
Still, the ingredients are there for stocks to undergo a rough patch if things go awry in the economy, Bannister said.
For one, the labor market appears to be on somewhat shaky ground, with unemployment and layoffs on the rise, and new job opportunities scarce. If the job market continues to worsen materially, then consumers could start to close their collective wallets. That’s bad news for an economy that derives 68% of GDP from consumer spending.
When you pair all of that with the fact that stock valuations are historically elevated, it could lead to trouble for investors. The median pullback in stocks during recessionary periods since World War II has been 20%, while the average drop has been 23%, the bank said.
“P/E doesn’t matter…until it’s the only thing that matters, and S&P 500 is expensive,” Bannister said.
If a bear market does arrive, the most speculative assets will fall first, followed by the broader market. A basket of seven highly-volatile stocks — including Palantir, Strategy, and GameStop — that Bannister tracks as a proxy for speculative appetite has fallen significantly over the last few months.
Bannister flagged a couple of ominous charts in his note that paint a worrying picture. One highlighted the runaway nature of a rising unemployment rate.
Stifel
The other showed the S&P 500’s equity risk premium, or the expected returns for stocks (given where valuations currently are) above the risk-free return offered by Treasury yields. It’s approaching levels seen during the dot-com bubble of the late 1990s and early 2000s.
Stifel
Again, Bannister’s base case is for the S&P 500 to post positive returns in 2026. But with the above risks in mind, he recommended building a hedge position with defensive stocks.
Funds like Consumer Staples Select Sector SPDR Fund (XLP), the Invesco S&P 500 Low Volatility ETF (SPLV), the JPMorgan Equity Premium Income ETF (JEPI), and the iMGP DBi Managed Futures Strategy ETF (DBMF) offer exposure to traditionally defensive assets.