S&P 500 could drop another 33% in a 1970s-style inflation environment: Société Générale

A Wall Street equity strategist warned this week that the bear market in stocks may not be over yet — and it may have more time to run if the economy falls into a 1970s-style stagflation scenario.

The S&P 500 officially entered a bear market last week, dropping more than 20% from its record high end on January 3. US stock index is on track for a historically ugly half year performance as markets anticipate tightening monetary policy to control inflation but fear interest rates will rise to recessionary levels.

“We have been and remain in a ‘de-risk, defensive, de-rated’ mindset for 2022, where the Fed’s rises in the current downturn are supposed to do collateral damage, leading us to adopt a bearish stance towards the US consumer, financial and small institutions,” said Manish Kabra. “But it appears that a committed fight against inflation will unleash a domino effect, as the housing and credit markets look like the next dominoes to fall.”

If the Fed fails to control rates, a 1970s-style inflation shock followed by a recession could push the S&P 500 SPX,
-0.13%
Capra said it is down another 33% from its current level to trade at 2,525.

The S&P 500 drops an average of 33% during a typical recession, but “the current 24% decline in stocks indicates that we have discounted 72% from the average recession (i.e. a 72% recession probability priced in)”, According to Société General Report. “At the 3200 level, the S&P 500 will completely cut the usual slump.”

The S&P drops an average of 33% during a typical recession, and the current 24% drop indicates that the probability of a recession of 72% has been underestimated, SocGen says. Source: FACTSET, BLOOMBERG, REFINITIV, SG CROSS RESEARCH / US Equity STRATEGY

The S&P500 fell 0.1% near 3,762 late Wednesday after Federal Reserve Chairman Jerome Powell confirmed his anti-inflation plan and said the US economy could handle a sharp rise in interest rates. Dow Jones Industrial Average DJIA,
-0.15%
It was flat near 30.530.

Read more: Dow, S&P 500 rose after Powell said the Fed is not trying to provoke a recession as interest rates rise

“We continue to see the fair value of the S&P 500 at 3850 and reach 5,000 by 2024 when the inflation shock should have moderated, and the Fed will likely not only have finished hiking, but also started the rate-cutting cycle and the US 10- general yield TMUBMUSD10Y,
3.162%
It’s closer to 2% again,” Capra wrote in the report.

US Treasury 10-Year Yield TMUBMUSD10Y,
3.162%
The note fell 14 basis points to 3.16% on Wednesday. Treasury yields move opposite the price.

Sluggish 1970s-style growth + low multiples = S&P 500 at 2525. Source: FACTSET, BLOOMBERG, REFINITIV, SG CROSS RESEARCH / US EQUITY STRATEGY

Consumers will continue to feel the impact of higher prices for another year amid negative wage growth as retail gasoline prices are at an all-time high and mortgage rates are at their highest since 2008.

Read more: ‘The savings and income needed to qualify for a home loan have skyrocketed’: Five ways that left the housing market for buyers in the dust — and it’s not over yet

“The main reason for our decline for the American consumer has been negative real wage growth over the past four quarters,” Capra said. Moreover, real wages are unlikely to be positive until the summer of next year.

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