Goldman Sachs suggests that the most significant risk currently facing the U.S. economy could actually be a stock market correction. The bank's U.S. economist, Pierfrancesco Mei, holds a generally optimistic outlook for the U.S. economy in 2026, projecting a 2.5% year-over-year GDP growth in the fourth quarter. This is primarily attributed to a favorable combination of fiscal stimulus, accommodative monetary policy, and easing tariff headwinds. However, he also expresses concern that a sharp decline in stock prices could dampen this expansion.
For instance, he notes that a 10% correction in U.S. stocks during the first half of the year could potentially reduce his GDP forecast by 0.5 percentage points, lowering it to 2.0%. A more severe stock market downturn would cause even greater damage. A chart included in Mei's 16-page report, published this Monday, indicates that a 20% decline in the stock market could result in GDP being nearly one percentage point lower than his baseline prediction.
"Our analysis suggests that a substantial equity market correction represents the most significant near-term risk," Mei wrote. The underlying logic is that a correction would impair the so-called "wealth effect." This refers to the phenomenon where households holding significant amounts of stocks and real estate feel financially secure and are inclined to spend more when their assets appreciate, even if their income growth lags.
In recent years, this effect has primarily benefited higher-income households, as they are more likely to be invested in stocks, which have repeatedly hit new highs since the debut of ChatGPT in late 2022. Over the past three calendar years, investors in the S&P 500 would have achieved cumulative returns of 64%. During the same period, the value of holdings for investors in NVIDIA (NVDA) would have surged over 450%.
Admittedly, Mei writes, no single factor is likely to push the economy into a recession unless it is exceptionally large or results from a combination of multiple risks. Examples of such combined risks could include a stock market sell-off occurring alongside AI-driven job displacement and limited productivity growth. In such a scenario, he suggests the Federal Reserve would likely respond by cutting interest rates.
However, significant portions of the U.S. economy are already experiencing recessionary pressures within what is termed a "K-shaped" economic phenomenon. In this dynamic, the highest-income consumers continue to spend, while the lowest-income groups struggle to afford essentials. "A stock market correction would transform the wealth-effect boost we anticipate into a drag on consumption in the second half of 2026," Mei wrote.
Currently, the highest-income consumers are underpinning the U.S. economy. According to Moody's Analytics, while consumer spending accounts for two-thirds of the U.S. economy, the top 10% of consumers contribute nearly half of the total expenditure. Perhaps more concerning is that a stock market correction could appear particularly severe during a volatile midterm election year.
Data from Aptus Capital Advisors shows that historically, midterm election years have experienced an average intra-year stock market decline of 19%. On Wall Street, a decline of 10% or more is typically defined as a correction, while a plunge of 20% or more is characterized as a bear market.
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