How Stagflation Could Derail a Market Fueled by ‘Hopium’ and Send Stocks Down 15%

Morning trading on the New York Stock Exchange last week. (TIMOTHY A. CLARY / AFP via Getty Images)

Stifel chief equity strategist Barry Bannister, who predicted the market selloff earlier this year, is worried again now that stocks have come roaring back.

Bannister is concerned about what he called “very extended valuations” in an atmosphere he compared with the Wall Street euphoria of the late 1990s. The Magnificent Seven stocks are surging and the market for initial public offerings is vibrant once again, so something has got to give, he says.

So what may go wrong? Bannister thinks that “a sudden economic slowdown” in the second half of this year will trigger a selloff that could push the S&P 500 all the way back down to 5500. The index closed at 6389.45 0n Friday.

“Slowdowns come in different forms and this one is stagflation, which is already noticeably slowing consumer spending,” Bannister said. The current boom in capital investments on artificial intelligence, plus the wave of spending early in the year to get ahead of anticipated tariffs, can’t prop up the economy indefinitely, he said.

With that in mind, Bannister said, the rebound that has lifted the S&P 500 by more than 30% from its “Liberation Day” lows in early April, isn’t sustainable. The S&P 500 is now trading at 24 times the per-share earnings its component companies are expected to generate this year, compared with its five-year average of 22 times.

“Valuation doesn’t matter until it does,” he wrote, noting that stocks eventually, and famously, crashed due to the weight of unreasonably high prices in 1929, 2000, and 2022. “We are uncomfortable with the S&P 500…as the economy slows to a crawl,” Bannister wrote.

Bannister isn’t advocating that investors bail from the stock market entirely. Instead, he argues that traders put a greater share of their money into so-called defensive value sectors such as consumer staples and healthcare.

Along those lines, Bannister listed several stocks in those sectors that Stifel rates at Buy. The names include Philip Morris, Altria, Mondelez, General Mills, Abbott Laboratories, Stryker, Boston Scientific and GE Healthcare.

These two sectors are reasonably valued: The Health Care Select Sector SPDR and Consumer Staples Select Sector SPDR exchange-traded funds trade at 17 and 20 times earnings estimates for this year. That is a bit below their five-year averages.

It’s also worth noting that healthcare stocks have been a laggard this year. The healthcare ETF has fallen more than 5%, partly because of concern over how Health and Human Services Secretary Robert F. Kennedy Jr.’s policies will affect big insurance and pharma companies.

Staples, on the other hand, are up about 4%, mainly as a result of big gains for discount retailers Costco and Walmart , which have the two largest weightings in the sector. Even though they are categorized as staples companies, they clearly also benefit from increased discretionary spending.

The market has rallied on what Bannister has dubbed the “powerful drug” of “hopium.” Further expectations that the Federal Reserve is coming to save the day could fuel more euphoric gains, but Bannister believes the rally will eventually end, echoing criticism from President Donald Trump that the Fed may be too late in cutting interest rates.

Write to Paul R. La Monica at paul.lamonica@barrons.com