Deutsche Bank: Calm in the markets before the storm and the big dive

Her Eleftherias Kourtali

The factors that led to the sell-off of the markets in the first quarter of the year have now been valued and so Deutsche Bank estimates that the shares will perform very well in the rest of this year, however it rings a bell for 2023 as it estimates that the US will sink into recession leading to a 20% dip in markets.

More specifically, as Deutsche Bank notes, there were three factors behind the correction of the first quarter in shares.

The first phase of the sell-off was driven by mega caps and tech stocks due to profitability concerns, given their very high ratings since the pandemic outbreak.

The second phase was led by the escalation of the geopolitical front that began on February 11 with President Biden’s speech on the impending Russian invasion of Ukraine. Within 17 trading days, the shares plunged 7.4% and then regained the lost ground very quickly in 6 trading days. This pattern conforms to the typical S&P 500 trajectory around geopolitical events and risks, as Deutsche Bank points out, where it makes sharp short-term corrections for 3 weeks of 6-8%, and then recovers to previous levels within 3 weeks.

The third driver was concerns about the Fed’s rate hike cycle, the effects of which appear to have been more episodic than persistent. These concerns stem from observations that in 8 of the Fed’s 11 growth cycles (73%) the economy ended in recession.

What do these three correction guides show for the future of the markets? According to Deutsche Bank, the first driver of the sell-off, the overvaluation of mega caps and technology, is a constant concern for 20 months. They have fallen against the S&P 500 since July 2020 and the valuation premium has been reduced, but remain above their fair value. However, a correction in the premium does not require a correction of the market, the German bank emphasizes, as the relevant valuations can be corrected through the faster increase of profitability.

The second factor that led to the correction, geopolitical risk, seems to have already been assessed in terms of its impact on markets.

Regarding the Fed’s interest rate hike cycle, the focus of current market concerns, DB notes that while nearly three-quarters of past cycles have declined, it has taken an average of 2 years to do so. set the recession in the spring of 2024. Shares tend to peak 3-6 months before the start of the recession, so the peak would be at the end of 2023. The bank notes that stock returns were very positive in the first year of cycles The Fed raised interest rates, with 10 in 11 cycles having positive returns of 7% on average, again indicating that it will not affect stock returns this year.

Based on the above, Deutsche Bank maintains its forecasts for the S&P 500 (5250 points) and the Stoxx 600 (550 points) for the end of 2022, however, expecting a formal correction due to a recession of 20% at the end of 2023. Its stock supply-demand forecast for this year suggests that stocks will be supported by strong capital inflows and a recovery in investor positions, but that support will begin to slow along with economic growth in the second half of next year. It will have effects but limited on the profitability of European listed companies from the Russia-Ukraine war and the valuations will recover, he estimates. In 2023, DB expects stock markets to perform very well throughout the summer before the US falls into recession and stocks recover by 20% as the recession begins.

It is worth noting that Deutsche Bank expects the Fed to raise interest rates by 50 bp in each of the next three sessions, while interest rates will peak above 3.5% next summer. This tightening is expected to lead the US recession for two quarters during the autumn-winter 2023-2024, with growth but then recovering as inflation recedes and the Fed reverses some of its interest rate hikes.