S&P 500 Correction 'Justified', Says Deutsche Bank; Fed Hike Likely in Sept. if S&P Over 2000

August 26, 2015 9:51 AM EDT

The recent market correction in the S&P 500 is justified, said Deutsche Bank strategist David Bianco. He described the market is "better without the froth," and noted a number of risks to monitor including China, capex, the Fed, and FX.

If the S&P is over 2000, Bianco thinks the Fed could hike rates in September, though it could be 'one and done' through the first half of next year.

"We see the S&P's correction as justified. It was a bit more than expected, but the impact of China's slowdown to commodities, currencies, global investment spending and trade are substantial drags to S&P EPS growth that have yet to fully emerge and be understood," said Bianco.

The strategist continued, "We think China's slowdown stays controlled. It's rather countries and companies that sell things to China that worry us the most. Until China and global growth outlooks are clearer, and how the Fed fits into the picture, we think stocks stay below prior highs. This uncertainty likely lasts through autumn given the Fed and 3Q S&P EPS likely being flattish again."

Bianco thinks investor should watch commodity prices and the US labor market for clues.

"Commodity prices, global manufacturing and trade reports will provide good China clues, particularly for what’s relevant for S&P Energy, Materials and Industrial stocks. The US labor market, particularly unemployment, participation and unit labor costs will provide good Fed clues. Any further divergence between these two forces (weak China, tight US labor market) and the dollar could surge. The recently stronger Euro and Yen is unwanted at home and unlikely to last. It’s probably better that Fed hikes weaken these currencies soon, rather than ECB or BOJ actions doing so, as eventually Fed hikes will come and weigh further," said Deutsche Bank.

Bianco added, "Our expectation for revisiting correction levels is in part because we think the Fed hikes despite slow growth. The Fed not hiking might reduce S&P downside risk this autumn, but we think it would equally limit upside potential until a hike occurs. We think the best scenario for the S&P over the next 6-12 month period is the Fed hiking sooner rather than later, while communicating a likely FF rate path that doesn’t exceed 1% in 2016 and not above 2% in 2017. further PE expansion can help drive good S&P gains despite slow EPS growth."

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