The S&P 500 decline has not played out. History suggests it will.

The stock market is likely to fall some more.

The U.S. stock market put in an impressive reversal on Tuesday, but more selling lies ahead. Here’s why:

• Further signs of U.S. economic weakness will stoke deeper recession fears, sending stocks lower. 

• Investor sentiment is dark but remains mixed. It has not turned bearish enough to be a contrarian buy signal. 

The next big pain point will likely come on Friday, March 7, when investors get a fresh U.S. employment report. The good news is, there’s probably no recession coming. So this likely won’t turn into a full-fledged bear market, defined as a 20%-plus decline. A garden-variety S&P 500 correction (down 10%) is more likely. 

Here are three key takeaways for stock investors now:

• If you were thinking of adding to positions, you might get better prices ahead. 

• If you are a long-term buy-and-hold investor, do not sell to try to dodge further declines and add back later. Market-timing seems easy, but is nearly impossible in practice. 

• Long-term investors may want to step up dollar-cost-averaging into the market in this weakness — now and over the next few weeks. 

Here are four reasons why the market declines probably have further to go. 

1. Growth will continue to slow: To understand what’s going on in the markets, Jim Paulsen of Paulsen Perspectives offers guidance. Paulsen has made several good market calls over the decades and I have followed his work. He even guided investors away from tech stocks and into bonds in late 1999, right before the tech bubble blew up and bonds outperformed. 

Several weeks ago, Paulsen called the current market selloff caused by growth-slowdown fears. He posited that several contractionary forces would slow growth and spark recession fears that create a stock-market decline. He cited elevated Treasury bond yields, the strong U.S. dollar, slow money-supply growth and rising inflation. 

These contractionary forces aren’t done yet. “GDP growth is poised to slow toward or below 2% during 2025 and this sluggish pace could bring renewed widespread recession fears,” Paulsen observes. 

The chart below demonstrates why investor worries about a growth slowdown could get worse. It shows how a rising 10-year bond rate drags down the Citibank Economic Surprise Index. This creates recession fears, which hit stocks. 

In the chart, the 10-year bond rate is on an inverse scale, and is pushed forward by the three months it takes to impact economic surprises. If history is a guide, economic surprises will continue to dwindle, enhancing recession fears, which will further weigh on stocks. The 10-year bond rate peaked at 4.8% in mid-January. This suggests that U.S. economic momentum may continue slowing until sometime in April, considering the three-month lag effect.

2. U.S. financial conditions are in a downtrend: The Bloomberg Financial Conditions Index tracks the health of the financial sector — which impacts growth. U.S. financial conditions have been weakening all year. Weakness caused a 10% S&P 500 correction in 2023, and a nearly 20% decline in the so-called Magnificent Seven stocks last summer. The sharp downturn in the past few weeks suggests the impact on the economy and stocks is not yet fully priced in.

3. The market signals more weakness ahead: The stock market often predicts economic trends. For example, when consumers are cautious, they spend less on discretionary goods like trendy fashion items, compared to everyday staples like toothpaste. This is reflected in the relative price performance of these stock groups. 

The chart below shows that typically when consumer discretionary stocks lag consumer staples stocks (that is, the ratio falls), the S&P 500 declines. The recent decline in this ratio is the second-largest in one month since 1990. So far, the typical S&P 500 decline has not yet played out. History suggests it will.

4. Sentiment might not be dark enough to signal stocks are a buy: Contrarian investors like to buy when sentiment is extremely dark. Sentiment has definitely worsened, according to the American Association of Individual Investors (AAII) sentiment survey. My rule of thumb here is that a buy signal appears when bearish investors exceed bullish investors by 10 percentage points or more for four weeks in a row.

But sentiment currently is not uniformly dark enough to signal the market is a buy, according to two key measures tracked by Bank of America. First, institutional buy-side investors are just about fully invested. Their cash positions are near a record low. 

Likewise, sell-side (retail) strategists are quite bullish. 

No recession

Paulsen expects U.S. GDP growth will slow to 2% and the yield on the 10-year bond will fall close to 3% — but the U.S. won’t slide into a recession. “The main reason is the lack of vulnerability in the private sector,” he told me in a telephone interview earlier this week. “No one has abused their balance sheets in this cycle to the point where they are in a vulnerable state.”

Meanwhile, Paulsen notes, the U.S. dollar has rolled over and bond yields are coming down. Both trends help spur growth. Next, he predicts, the Fed will go into easing mode later this year because of the economic-growth slowdown, which will take inflation down to 2% and give the Fed cover to ease.