Deutsche Bank Strategists See Risk of US Stocks Sinking 25%

(Bloomberg) — US stocks could slide a further 25% if the economy tips into recession, with risks to a sustained equity rally mounting, according to Deutsche Bank AG strategists.

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With company profits set to drop, stock valuations still high and recession risks looming, the fundamental picture for stocks is challenging, strategists led by Binky Chadha wrote in a note dated Sept. 7. Still, investor positioning in equities is low, they added.

“The outlook looks relatively binary: in the event we slide into a recession, the selloff has much further to go,” Chadha said, reiterating that the S&P 500 Index could slide to as low as 3,000 points in his worst-case scenario — nearly 25% lower than Wednesday’s close. If recession is avoided, “we expect the market to rally back sharply to its prior peaks,” he said. His base-case scenario still sees stocks rising by year-end.

Among the main risks for stocks are high valuations amid “elevated late-cycle earnings,” Deutsche strategists wrote. While the second-quarter results season was stronger than expected, that was mainly down to higher oil prices benefiting energy companies, Chadha said, adding that profit growth could slow from here, or even fall.

His outlook is consistent with peers at Goldman Sachs Group Inc. and Morgan Stanley, who warned this week that stocks could slide to fresh lows amid slowing economic growth. The S&P 500 has already erased about half of its summer gains as earnings optimism faded and investors fretted that the Federal Reserve would stay hawkish for longer.

Focus now is on Fed Chair Jerome Powell, whose speech later on Thursday could offer clues on how hawkish the central bank might have to get as it battles soaring inflation. US stock futures were subdued, a day after the S&P 500 notched its biggest jump in a month.

Chadha said, however, that with market positioning low and inflation data less likely to surprise to the upside, the equity benchmark may have room to move higher in October.

He maintained his year-end target of 4,750 points for the S&P 500 — up 19% from current levels. “Leading indicators are consistent with a descent into recession but not signaling we are in one already,” he added.

(Updates with US futures in sixth paragraph)

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