For those reading the business press, 2025 has had no shortage of headlines. Swings in the stock and bond market in April equalled some of the most extreme events of the last 40 years.

In its desire to reorganize global trade, the administration has warned of short-term pain for long-term gain. In line with that assessment, Wall Street economists have increased their recession probabilities. 

Alternative asset manager Apollo recently published a chartbook we recommend viewing at this link. They forecast significant layoffs by the end of May and a recession by summer. In another piece, they make the following observation: 

One way to quantify the coming negative impact on GDP is to compare the current tariff increase with the tariff increase observed during the trade war in 2018. During the 2018 trade war with China, the US average tariff rate increased from 2% to 3%, and studies show…that the impact on GDP was between 0.25% and 0.7%. Using the smallest of these estimates for the current tariff increase from 3% to 18% shows that the negative impact on GDP in 2025 could be almost 4 percentage points, not including additional non-linear effects because of the current increase in uncertainty for consumer spending decisions and business planning.

Given this potential impact, policies could change as negative data rolls in. Regardless, the risk of recession will remain elevated as long as the current tariff regime remains in place. 

What Happens To Stocks in a Recession?

Given this elevated risk, it is worth evaluating what that might mean for major asset classes, particularly stocks. Understanding the two key levers of downside—earnings and valuations—can help us assess where the market could go from here.

Corporate Earnings

Corporate earnings reflect underlying economic activity. In recessions, earnings decline due to falling demand, tighter credit, and cost pressures.

Historically, the severity of a recession dictates the depth of the earnings hit: 

• Mild recessions – earnings decline of 10-15%
• Moderate recessions – earnings decline of 15-25% 
• Severe recessions – earnings decline of 25-35% 

It is challenging to predict the severity of a recession in advance, particularly as fiscal and monetary reactions to such an event are unknowable. That said, if a downturn occurs, we can be relatively confident about the direction, if not the magnitude, of corporate earnings. 

Valuations

The other piece of the puzzle is what investors are willing to pay for those earnings. One way to measure this is using the forward price-to-earnings (P/E) ratio, which reflects how much investors are paying for a dollar of future earnings. 

The forward P/E of the S&P 500 is currently around 19x. During past recessions, valuations have fallen significantly, often to 14x or lower.

If tariffs prove inflationary, that would add further pressure to valuation multiples, as higher inflation often pulls real P/Es lower. The ~25% equity decline in 2022 was driven mainly by inflation-induced multiple contraction.

Bringing It All Together

Goldman Sachs recently produced research outlining potential scenarios for the stock market in 2025. In their recession scenario, S&P 500 earnings per share declined by 12%. Assuming forward P/E declined to 14x, that would leave us with a level on the S&P 500 of roughly 3000, or approximately 45% below where we are today. 

The jury is still out on whether we’ll have a recession in 2025. But knowing what the possibilities might be helps us assess risks and opportunities moving forward.