Multiple "Headwinds" Including US-Iran Tensions and AI Converging? Renowned Trader: S&P 500 Could Plunge 35% Within a Year!

A senior Wall Street analyst has issued a new warning that the U.S. stock market may be on the verge of a correction more painful than last year’s “Day of Liberation” sell-off.

Senior strategist and former Lehman Brothers trader Larry McDonald said he believes the market could face a larger decline in the medium term. He pointed out that this is due to multiple risk factors converging in the market. In an interview, he stated, “If the S&P 500 drops 20% to 35% from current levels in the first quarter of next year, I wouldn’t be surprised.”

“Risk-reward is just too poor. Most sectors in the market have already started to pull back. The seven hottest stocks have fallen 11% from their 2025 peak,” he added.

According to McDonald’s pessimistic outlook, the S&P 500 could fall to around 4,365 points, a level not seen since the end of 2023.

Here are the reasons behind his gloomy forecast:

1. Rising oil prices could make rate cuts more difficult.

The market has been concerned about the impact of the Iran-U.S. conflict causing oil prices to surge. There are worries that higher crude prices could push inflation up, which might dampen the market’s expectations for Federal Reserve rate cuts.

Investors have yet to see any inflation data reflecting Middle Eastern supply disruptions, but Americans are already paying higher prices at the pump. According to AAA, the national average for gasoline rose to $3.84 per gallon on Wednesday, up from $2.92 a month ago.

Federal Reserve Chair Jerome Powell said after the latest policy meeting that the impact of Middle Eastern developments remains uncertain. The Fed will closely monitor various risks, and it is too early to judge the scope and duration of their economic impact. The latest dot plot indicates only one rate cut this year.

“Prolonged high oil prices will weigh on consumption. We really don’t know what impact rising energy prices will have. Oil shocks can be offset by U.S. energy production, and if oil companies believe this rally will continue, they will increase output,” he said.

2. Rising interest rates will increase risks in the credit markets.

The Fed’s prolonged high-rate environment is bad news for many types of loans, including commercial real estate loans and private credit.

McDonald noted that many loans issued during the pandemic when interest rates were extremely low are about to mature. When these loans eventually mature in a high-interest-rate environment, they could introduce new credit risks to the financial markets, potentially affecting the bond market and ultimately the stock market outlook.

He mentioned factors that could pressure the market: “Interest rates were only 1% back then, so a lot of junk loans were sold. Therefore, the market faces both interest rate risk and credit risk.”

3. The disruptive impact of artificial intelligence may continue to spread across the entire market.

McDonald said that due to investor concerns about AI’s long-term impact on various industries’ business prospects, the market sees “new victims” every day. He pointed out that fears of AI disrupting software companies’ business models initially hit tech stocks hard, then spread to insurance brokers, wealth management, real estate, and freight industries.

“The beast in the market will continue to devour these victims and relentlessly pursue them,” he added.

4. The U.S. may experience a peak in AI-related layoffs this summer.

McDonald believes that in the second half of the year, unemployment could accelerate, potentially impacting the economy and markets.

The U.S. unemployment rate has remained around 4%, but he speculates that with the rapid adoption of AI, the unemployment rate could rise close to 6% by year’s end. Based on his “reasonable estimate” of how quickly corporate leaders are adopting AI, he suggests that from April to July, the U.S. economy could lose 100,000 to 200,000 jobs each month.

He specifically mentioned fintech giant Block, which recently laid off 40% of its staff due to its ability to leverage AI to assist work.

“In the era of AI, unemployment will accelerate this year. I think that’s quite realistic,” he said.

Given the continuous decline in hiring and rise in layoffs over the past year, the job market has become a key focus for investors. In February, U.S. unemployment reached 92,000, well above expectations, raising concerns about a potential recession.

(Source: Caixin Global)