Stocks could drop 50% in a stagflation scenario – UBS simulation

New York (Nov 18)  If stagflation is in the cards for next year, stocks could drop up to 50%, according to a simulation run by UBS.

With inflation running hot globally and COVID-19 numbers still spiking across the globe, markets are starting to fear stagflation — a period described by high price pressures and slower economic growth.

Latest inflation data out of the U.S. showed the consumer price index hit a 31-year high in October as it accelerated to 6.2% on an annual basis. This is not a U.S.-only phenomenon. In Canada, inflation reached 18-year highs. And in the U.K., price pressures climbed to 10-year highs.

"Our simulations suggest that sustained inflation, even if mainly demand-driven, will see equities lose 10-15% cumulatively over three years. These losses likely amplify to 40-50% in the unlikely event of 'stagflation'," UBS strategists said in a note.

The first time stagflation made headlines was in the 1970s, following an oil shock, which triggered a jump in consumer prices and high unemployment rates.

With the Federal Reserve kicking off tapering in November, the fear now is the U.S. economic growth suffering as the country's central bank proceeds to tighten monetary policy to fight off high inflation levels.

UBS added that its simulation saw small-cap stocks seeing the most significant losses. For protection within the stock market, UBS advised looking at put options on semiconductors and small-cap companies.

Despite the massive equity selloff warning, UBS admitted that a stagflation scenario is highly rare and is not part of their base-case outlook for next year.

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