The selling has forced up the average interest rate on the bonds to 8.3 percent. If investors had faith in the economy, the rate would be 4.6 percent, Fridson says.
"I'm nervous," says Fridson, who has followed the junk bond market since 1984. "I think there's a very material risk of falling into recession."
Investors are responding to the risk by putting their money where they feel safe. Demand for the 10-year U.S. Treasury note was so high last week that the yield dipped below 2 percent for the first time in half a century. And the price of gold has set one record after another. It topped $1,800 an ounce last week.
Although unemployment remains stubbornly high, at 9.1 percent, there are signs that the economy, while not strong, is still growing. Retail sales grew in July at the fastest pace since March. Employers added 117,000 jobs last month — a modest gain, but far better than the hundreds of thousands of jobs lost each month during the Great Recession. Factory production rose in July because automakers made more cars.
And Wall Street analysts who analyze companies and advise investors when to buy and sell don't seem to be worried. As stocks were falling Friday, research firm FactSet released figures that showed just how much more optimistic these analysts are than the average investor.
Stocks are priced at roughly 11 times their expected earnings per share over the next year. That's a steep discount compared with the market's long-term average of 15 times. Translation: If you believe the U.S. will avoid recession and companies will generate profits as high as the analysts think they will, the S&P should be trading at 1,560 — just below the S&P's record high of 1,565 in October 2007.
Of course, if the economy is weak and earnings don't come in as expected, it could turn out that stocks were trading today at 15 times the next year's earnings. That's what many of today's sellers seem be expecting.
And skeptics note that analysts are notoriously bullish, and tend to overestimate profits as the economy slows. Wells Capital's Paulsen thinks stocks should be trading higher, though he suggests investors will pay a steep price if he's wrong.
"If we have a recession, we'll probably break 1,000" on the S&P index, he says.
Investors will be on edge this week as they scrutinize new data on the economy. On Tuesday, new home sales for July are released, followed on Thursday by a weekly report on how many people are joining the unemployment line. On Friday, the government will give its second estimate of how fast the economy grew from April through June.
The most anticipated event, though, is a speech the same day by Federal Reserve Chairman Ben Bernanke at a retreat in Jackson Hole, Wyo, sponsored by the Federal Reserve Bank of Kansas City. The Fed pledged earlier this month to keep interest rates super-low through mid-2013. Investors hope Bernanke will announce, or at least preview, further steps to help the economy. But economists say it is unlikely Bernanke will unveil anything ambitious.
With all the high emotion surrounding stocks, economist Joel Naroff cautions investors not to read too much into the recent swings. He says that stocks have a habit of running from one extreme to the other, including this spring, when he thought they were far too high. He thinks stocks may be fairly valued now.
They reflect an "economy that is growing but not growing at any great pace," he says. "It is not in recession."