‘We see major stock markets plunging 25%,’ says Deutsche Bank

A U.S. recession induced by central-bank efforts to curb inflation is likely to arrive by mid-2023 and trigger a sharp and “temporarily painful” decline in equities, according to Deutsche Bank researchers.

“We see major stock markets plunging 25% from levels somewhat above today’s when the U.S. recession hits, but then recovering fully by year-end 2023, assuming the recession lasts only several quarters,” said David Folkerts-Landau, group chief economist and global head of research, and Peter Hooper, global head of economic research.

In a note released on Monday, the researchers cited persistently high wage and price inflation in the U.S. and Europe driven by robust demand, tight labor markets, and supply shocks for their thinking. Based on the historical record of several major industrial countries since the 1960s, any time trending inflation has declined by 2 percentage points or more, such a decline has been accompanied or induced by a rise in unemployment of at least 2 percentage points. Currently, they estimated, inflation trends in the U.S. and Europe are running around 4 points above desired levels.

Deutsche Bank
DB,
-2.50%
isn’t alone in its thinking. In July, legendary investor Jeremy Grantham warned that stocks could plunge 25% as the “superbubble” continues to pop. In August, Citi research analyst Christopher Danley wrote that chip stocks could drop by that magnitude as investors enter “the worst semiconductor downturn in a decade.” And earlier this month, a team of analysts at Morgan Stanley
MS,
-1.13%
analysts led by Mike Wilson implied that the S&P 500
SPX,
-1.54%
could see further downside of up to 25% if a recession hits.

Read: S&P 500 to bottom in the first quarter, creating a ‘terrific buying opportunity,’ says Morgan Stanley’s Wilson 

A downturn may already be under way in Germany, where Deutsche Bank is based, and in the eurozone as a result of the energy shock triggered by Russia’s invasion of Ukraine, the Deutsche Bank researchers said. Meanwhile, the Fed and European Central Bank are “absolutely committed” to bringing inflation down in the next several years, and “it will not be possible to do so without at least moderate economic downturns in the U.S. and Europe, and significant increases in unemployment.”

“The good news is that we also think the Fed and ECB will succeed in their
missions as they stick to their guns in the face of what is likely to be withering public opposition as unemployment mounts,” Folkerts-Landau and Hooper wrote. “Doing so now will also set the stage for a more sustainable economic and financial recovery into 2024.”

U.S. stocks got a lift last week after the minutes of the Federal Reserve’s most recent meeting indicated that policy makers expect a slower pace of rate increases will likely be appropriate soon. On Monday, though, waves of protests in China triggered ripples of unease across financial markets, with all three major stock indexes, including the Dow Jones Industrial Average
DJIA,
-1.45%,
lower in morning trading.

In April, Deutsche Bank became the first major Wall Street bank to forecast a U.S. recession at some point. And in June, it saw a risk that inflation would either accelerate or fail to decelerate fast enough. The annual headline inflation rate derived from the U.S. consumer-price index fell to 7.7% in October after coming in above 8% for seven straight months.