Stock market could plunge 10% as economy faces stagflation threat, Stifel warns

There may be trouble on the horizon for the U.S. stock market, according to Stifel analysts.

In a Tuesday note to clients, the investment bank warned that stocks are headed for another sell-off that could see the S&P 500 tumble 10% by the end of the third quarter this year.

The analysts suggested that sluggish economic growth and stubbornly high inflation – the hallmarks of a phenomenon known as stagflation – will force the Federal Reserve to hold interest rates at elevated levels, disappointing investors who are hoping for several rate reductions this year.

"The no-landing (albeit with soft growth) scenario and increased resource utilization with stickier-than-expected inflation (a moderate form of stagflation) places constraints on the Federal Reserve which outweigh their preference to ease," the note said.

STAGFLATION FEARS COME BACK WITH A VENEGEANCE

Investors were previously betting on a series of aggressive rate cuts this year, but they have steadily dialed back those expectations amid cautious messaging from Fed officials and signs that inflation progress is slowing.

Market pricing now indicates the Fed will cut rates at least once or twice this year, and that the first reduction will come in September, according to the CME Group's FedWatch tool.

INFLATION INCREASES 3.4% IN APRIL AS PRICES REMAIN ELEVATED

But Stifel analysts predicted the central bank will not reduce rates at all this year as inflation remains abnormally high. 

"We continue to forecast the S&P 500 corrects about -10% to ~4,750 before the end of 3Q 2024 from the recent peak," they wrote.

Stocks notched a new record in mid-May, with the Dow Jones Industrial Average topping 40,000 for the first time ever, but they have since fallen from those highs. 

The indexes slipped on Tuesday as investors await key jobs data from the Labor Department. The Dow Jones Industrial Average shed 54 points, while the benchmark S&P was down about 0.34%.

The gloomy forecast from Stifel comes after a volatile year for the market.

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All three indexes tumbled in mid-2023 amid fears the Federal Reserve would raise interest rates higher than previously expected – and hold them at peak levels for longer. But they have recouped those losses and more, with the S&P 500 up more than 29% since it hit bottom at the end of October. 

Since the start of the year, the benchmark index is up about 10.6%, while the Dow Jones Industrial Average has climbed 2.5%. The tech-heavy Nasdaq Composite, meanwhile, has increased about 12% year to date.