The S&P 500 Index risks sinking 20% if inflation spikes on the back of higher oil prices, according to a report by RBC Capital Markets LLC strategists that laid out three possible pullbacks.
The strategists, led by Lori Calvasina, said US equities are vulnerable given the recent rally and valuations look stretched. The broader the Middle East conflict becomes and the longer it lasts, the more negative it will be for US stocks, they said.
In a worst-case scenario, they see the S&P 500 returning to its April lows if the attacks drive up energy prices. And in a less-severe case, the index may fall about 13%, the strategists said.
“The conflict has the potential to generate some additional angst about the health of the consumer, the broader economy, and the path of the Fed, a narrative shift that seems likely to be problematic for stock prices,” the strategists wrote in the note.
For now, markets have been relatively calm despite the intensifying clash between Israel and Iran. Oil prices dipped on Monday after a 7% rally on Friday, with investors saying that the conflict so far has avoided major energy facilities and seems limited between the two countries. Still, with the attacks entering a fourth day, there’s the fear that it may escalate to a wider regional war.
The RBC analysis shows the benchmark could drop to as low as 4,800 points — nearly 20% below current levels — by the year end in the case of a “severe” inflation spike to 4%, zero earnings growth from 2024, only two interest-rate cuts by the Federal Reserve and 10-year Treasury yields remaining at current levels.
In the milder situation, they see earning growth this year at 7% and the S&P 500 ending the year around 5,200. The bank’s year-end target for the index is 5,730, about 4% below current levels.
Other strategists remain optimistic about the outlook for corporate earnings and the US stock market. Morgan Stanley’s Michael Wilson said in a note Monday that some metrics suggested earnings would come in stronger-than-expected over the next year.
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