US stocks could retreat a further 25% if the economy slips into recession, with the risk of a sustained rally in stocks, according to strategists at Deutsche Bank.
With corporate earnings set to contract, stock valuations still high, and recession risks looming, the fundamental outlook for equities looks complicated, strategists led by Binky Chadha wrote in a note dated September 7. . However, investor positioning in stocks is low, they added.
“The outlook looks relatively binary: Should we slip into a recession, the sell-off has a lot more ahead of it,” Chadha said, reiterating that the S&P 500 index could drop as low as 3,000 points in a worst-case scenario, almost 25 percent. % below Wednesday’s close. If the recession is averted, “we expect the market to bounce back strongly to previous highs,” he said. His base case still sees stocks rising by the end of the year.
Among the main risks for stocks are high valuations amid “big late-cycle gains,” Deutsche strategists wrote. While the second-quarter earnings season was stronger than expected, that was mainly because higher oil prices benefited energy companies, Chadha said, adding earnings growth could slow from from here, or even fall.
His view echoes those of peers at Goldman Sachs and Morgan Stanley, which this week warned that stocks could fall to new lows amid slowing economic growth. The S&P 500 has already erased about half of its summer gains amid fading optimism about earnings and investor fears the Federal Reserve will remain hawkish for longer.
The spotlight is now on Fed Chairman Jerome Powell, whose speech later on Thursday could offer clues as to how hawkish the central bank may have to become as it battles soaring inflation.
However, Chadha said that given the low market positioning and the lower likelihood of inflation data surprising to the upside, the benchmark equity index could have room to rise in October.
The expert maintained his year-end target of 4,750 points for the S&P 500, up 19% from current levels. “Leading indicators are in line with a slide into recession, but do not indicate that we are already in one,” he added.