The stock market will fall another 25% if job growth slows and an economic recession materializes, DataTrek says

• An economic recession would send the S&P 500 another 25% lower to 3,000, according to DataTrek Research.
• DataTrek believes the Fed is trying to drive a slowdown in job growth to contain rising inflation.
• Slowing job growth could cascade into a recession, but for now the S&P 500 is proving resilient.

The stock market could fall another 25% if interest rate hikes from the Federal Reserve spark an economic recession, according to DataTrek Research.

The Fed has a tough balancing act as it attempts to tame rising inflation without sending the economy into a downward spiral. One way the Fed can achieve its goal of a soft landing is by convincing corporate America to slow its hiring frenzy, DataTrek co-founder Nicholas Colas said.

But it is a delicate balancing act. The Fed is looking for just the right amount of job growth to keep the economy humming without contributing to spiking inflation.

That's because since 2020 there has been a strong correlation between job openings and core PCE inflation. "We know that a lot of those JOLTS job postings are to attract people who are already employed. This leads to wage inflation. And that leads to outsized consumer demand, which drives inflation," Colas explained.

"The Fed's goal is to convince corporate America to enact a short-term hiring freeze, and it will keep raising rates and talking about aggressive monetary policy until that happens," Colas said. The Fed has even more reason to keep raising interest rates after Wednesday's CPI report showed inflation remained elevated in April.

For the stock market to price in just a 50:50 chance of an economic recession occurring, the S&P 500 would have to trade down to 3,525, representing potential downside of 12% from current levels.

And if the economy goes into a full-blown recession, the S&P 500 would trade at around 3,000, according to DataTrek, representing downside potential of 25% from current levels. That's based off of a price-to-earnings multiple of 18.5x and a significant drop in corporate earnings, to $161 earnings per share for the S&P 500.

But for now, the S&P 500 is proving resilient as it trades near 4,000 and is not yet pricing in an economic recession at current levels.

"As bleak as things look now, there are still pathways out of the mess markets find themselves in. Recent volatility simply says investors think the window of opportunity to get back on the right track is closing. It is not shut yet, otherwise the S&P 500 would be at 3,500 or even lower," Colas said.

Ways for the stock market and economy to get back on the right track include corporate America taking the hint from the Fed and slowing down its hiring frenzy, and a resolution to the Russia-Ukraine war, which would help alleviate inflationary pressures.