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Deutsche Bank: 'An 8-10% S&P decline looms'

This has been the calm before the storm. (Image: Flickr / Anthony Quintano)

Friday was a rough day for the markets.

The S&P 500 (^GSPC) fell a whopping 53 points, or 2.45%, to close at 2,127. This came after 42 straight trading sessions where the S&P made a move no greater than 1%. So, the market was arguably due for some volatility.

Deutsche Bank’s David Bianco believes there’s a lot more downside to look forward to.

“An 8-10% S&P decline looms,” Bianco said on Friday. “S&P realized volatility has been extremely low the last 6 weeks, but we think this is the quiet before the storm.”

He identified five “catalysts to increased volatility” in the weeks ahead:

  1. Analysts cutting their outlooks for earnings in 2017.
  2. The Fed not hiking rates in September, while offering no clarity on when the next rate hike will occur.
  3. Capital expenditures going sideways.
  4. The US presidential election and related policy uncertainty.
  5. Low bond yields distorting valuations in various stock market sectors.

What makes market particularly vulnerable is the combination of bullish sentiment and complacency observed.

“We take concern with this very low volatily amidst low volume and high PEs,” Bianco said. “One of our favorite risk sentiment indicators, which we use in a contrarian fashion, the PE/VIX ratio signals a very complacent market.”

The markets look complacent. (Image: Deutsche Bank)

Bianco joins his peers on Wall Street who have been warning clients of heightened volatility and lower stock prices.

On Friday, Goldman Sachs’ David Kostin also offered a list or reasons why stocks should go down. From Kostin’s note: “Five reasons we continue to forecast S&P 500 will end 2016 at 2100, roughly 1% below the current level: (1) Our Sentiment Indicator shows an extreme bullish reading of 95 which suggests the index will decline during the next four weeks; (2) Political uncertainty will rise as the election approaches leading to a lower P/E multiple; (3) Recent economic data has disappointed; (4) Downside risk to EPS forecasts; (5) Equity valuation remains extended.”

But to be clear, this is not a unanimous view.

“We think the US stock market is going higher,” Morgan Stanley’s Adam Parker said last Monday. Rather than focusing on the near-term, Parker looks longer term arguing that the S&P heads to 2,300 in 12 months and 3,000 by 2020.

One thing’s for sure: there are a lot of important events coming up, and it’s unclear how any of these events will turn out.

Sam Ro is managing editor at Yahoo Finance.
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