I've seen analysts saying probability of a global recession is anything from 20 to 80% - my take is we are probably more likely than not to go into recession but how deep it is depends on what happens in Europe - is the situation is contained we may have slow growth or a mild recession....that is roughly the same. But has the stock market priced that in? ....
The graph above shows the price of stock relative to book value. Book value rough speaking is the amount of money that a holder of a common share would get if a company were to get liquidated i.e. stop its business and sell off all assets. If ever the stock price falls below the book value, value investors would consider it a real bargain and stocks are absolutely cheap because you can technically liquidate the company and get all your money back plus profits. Stocks have fallen below book value only twice in the last 25 years both times during a crisis - the Asian Crisis and Financial Crisis. During a garden variety recession stocks do fall but stay above the book value.
Using book value as a reference, the recent stock market fall has taken us roughly to valuation levels just after the 911 attacks in Sep 2001 - remember the post-dot com bubble recession? It was a slow drop for stocks that took about a year as stocks slowly but steadily drop as the economy slowed towards a recession - then the 911 attack suddenly came people were already expecting a recession. There was a post-911 bounce when the US Fed cut interest rate aggressively but SARS cam and took further below the post-911 low.
The stock market right now discounts a mild recession and definitely discounts a slowdown in the global economy. However, it does not discount some kind of crisis like SARS or a financial crisis.
The big question now is whether the European debt situation can be contained and stabilised....and put into some kind of graceful degradation to spread the pain over time. Speculators attacking the stocks of European banks attempt to precipitate a crisis and we know from past crisis that they can succeed bringing down the European banking system and put the European economy into a deeper recession than necessary. In an earlier article, I explained that large amount of Greek and Italian debt held by German and French banks links the sovereign debt crisis to the European banking system . I'm not optimistic that the worst case will not happen especially after seeing the disunity among European leaders. Having said that the ESFS[Link] is probably sufficient to buy some more time provided the govts step in to aid the banks (read Why European Banks are Stressed out? and Faith in European Banks Fraying). They might not because it is politically unpopular[Investors Fret at costs if rescues are needed] and Ireland got itself into a mess because the govt's rescue of the banking system sank the country into deeper debt. If they want to do something about the banks, they will have to do it soon otherwise it will become too expensive and too intractable. Something like Buffett's US$5B injection into Bank of America [Buffett Pockets $1B in BoA 'rescue']can do wonders to restore confidence. If nothing is done soon, this crisis will run its full course....and you may get the chance to buy stocks below book value just like during the Asian Crisis and the Fincnial Crisis. [Here is an excellent paper explaining in full the situation in Europe and possible outcomes : Europe on the Brink]