Shilling Forecasts a 30%-40% Drop in U.S. Stocks

Shilling says several catalysts could reverse the gains in stocks: a second wave of the virus, which would force renewed lockdowns — the current spread is due to an expanded first wave; evidence that consumer spending and production isn't picking up due to fears about the virus; or an end to expanded unemployment benefits — they are set to end on July 31, if no additional congressional action is taken.

Shilling likens the current stock market to the market in fall 1929 into the early 1930s, when a stock market crash in September to November was followed by a rebound that erased about half the earlier losses, only to be followed by the Great Depression, causing stocks to plummet again. They bottomed out in July 1932, down 89% from their September 1929 peak.

The S&P 500 this year fell 35% between Feb. 19 and March 23, followed by a rebound that erased about three-quarters of those losses. "Now the jump in infections in early-opening states and the likely unfolding of a long and deep recession will probably drive the stock market down by 30% to 40% from the current level," writes Shilling.

Unlike the most optimistic economists and strategists who expect a V-shaped recovery or the more pessimistic ones who anticipate a U-shared or W-shaped one, Shilling is forecasting an L-shaped economy, characterized by stagnant growth.

Federal Reserve policies of near zero interest rates, massive asset purchase and multiple lending facilities to increase liquidity will not be sufficient to revive a weakening economy, says Shilling. "There's much more Fed-created liquidity out there than consumers and businesses want, which suggests a weakening economy economy and falling stock prices in the future."

— Related on ThinkAdvisor:

• Gary Shilling: Recession Will Last Into 2021
• Gary Shilling: 13 Predictions for a Post-Coronavirus World
• Why Haven't Rising COVID Counts Crushed Stocks? 3 Possible Explanations