Three major Wall Street banks expect the S&P 500 to tank over 20% at some point next year.
US stocks face a recession, cuts to earnings outlooks and liquidity risks as the Fed hikes rates.
Here's what Morgan Stanley, Bank of America and Deutsche Bank say about what could drag stocks lower.
Three top Wall Street banks are singing from the same downbeat hymn sheet, as each predicts US stocks could fall by more than 20% next year.
For Bank of America, a Federal Reserve-induced liquidity crisis could put pressure on the S&P 500 stock index. Meanwhile, Morgan Stanley and Deutsche Bank say lower earning outlooks and a US recession could trigger the selloff.
The benchmark index has risen from October lows to around 4,000, but analysts believe the rally is just a respite in the bear market it entered this year.
The Federal Reserve's aggressive interest-rate hikes to combat inflation at 40-year highs, fears its tightening could tip the US into recession, and the fallout from Russia's invasion of Ukraine have pulled the S&P 500 down 15% in 2022.
It's now payback time for stocks, which got used to decades of low interest rates and easy money from fiscal and corporate stimulus. Here's where the S&P 500 is headed, and why, according to the major banks.
Morgan Stanley expects the S&P 500 to fall 24% to between 3,000 and 3,300, probably in the first four months of 2023. Its chief US equity strategist, Mike Wilson, sees a build-up of companies lowering their earnings outlooks then due to recession, which hits stock valuations.
"That's when we think the deceleration on the revisions on the earnings side will kind of reach its crescendo," Wilson told CNBC.
An economic downturn tends to mean businesses and consumers cut spending, which translates into lower corporate revenue. Higher interest rates make the cost of borrowing and so investing more expensive for companies.
"The bear market is not over," he said. "We've got significantly lower lows, if our earnings forecast is correct."
Wilson sees the S&P 500 finishing 2023 near 3,900, but predicted a high level of volatility in the market.
"So, while 3,900 sounds like a really boring six months - no, this is going to be challenging. It's going to be a wild ride," Wilson said. He added lower earnings will cause intense pain for larger-cap stocks, and not just tech stocks.
Bank of America
Markets will be ravaged by a recession next year, with a 0.4% drop in economic growth coming in the first quarter, according to Bank of America.
It also predicts the S&P 500 could lose 24% from current levels to hit as low as 3,000, as companies are forced to cut earnings outlooks. That would mark a new low in the prevailing bear market cycle.
But there's another risk: The Fed's quantitative tightening (QT) - where it trims around $95 billion in Treasury bonds and mortgage-backed securities each month from its $9 trillion balance sheet - could badly disrupt market liquidity.
Bank of America said the coming recession will be different, in part because of the "biggest bubble" is in "monumental, unprecedented leverage risk at governments and central banks", rather than with consumers and businesses. That could lead to liquidity risks in odd places, such as the S&P 500, given the Treasury market feeds into equity pricing.
The bank also expects the benchmark index to end 2023 at 4,000, but to suffer price swings along the way.
In its 2023 outlook, Deutsche Bank said it expects global stocks to drop sharply as a severe and protracted downturn hits the US economy. But it sees the slump in US equities coming in the middle of the year, rather than in the early months.
It forecast the S&P 500 will rally to 4,500 in the first half, then will tank by over 25% in the third quarter, as central bank tightening tips the economy into full recession. That would take the index to 3,375.
"We read the Fed and ECB as being absolutely committed to bringing inflation back to desired levels within the next several years," David Folkerts-Landau, chief economist at Deutsche Bank, wrote in a note.
"Although the costs in doing so may be lower than in the past for reasons we lay out, it will not be possible to do so without at least moderate economic downturns in the US and Europe, and significant increases in unemployment," he added.
Deutsche Bank was also downbeat on corporate earnings, and it sees earnings per share sinking on average from $222 this to $195 the next.
Its team likewise sees stocks recovering by the end of 2023, as long as the recession doesn't last beyond several quarters. The S&P 500 should bounce back to 4,500 by the close of the year, according to the bank.