Higher Rates No Barrier for Stocks if Growth Holds, Deutsche Bank Says

Equity markets will remain supported into the end of the year despite a return to more typical levels of volatility, according to strategists at Deutsche Bank. The bank's analysts argue that stocks can absorb the impact of higher interest rates as long as they are accompanied by solid economic growth and inflation data.

Market Shifts to a 'Bumpy' Ride

A period of historically low realized volatility in August has given way to a more turbulent market, a team of strategists led by Maximilian Uleer said in a note. They attribute this shift to several factors, including rising interest rates, persistent inflation, growing political uncertainty, and investor concerns around the pace of spending on artificial intelligence.

Despite these headwinds, Deutsche Bank maintains a constructive outlook. "We expect equities to remain supported as long as higher rates are accompanied by higher growth and higher inflation data," the strategists wrote. They also noted that a potential de-escalation of geopolitical tensions, such as the conflict in Iran, could provide a further boost to market sentiment.

Regional and Sector Views

Deutsche Bank remains "tactically Neutral" between U.S. and European equities. While European macro surprises have been more positive and earnings momentum appears stronger, the bank noted that absolute U.S. earnings growth remains "exceptional and broad-based."

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Within Europe, Germany is the bank’s favored market, citing improving economic data, ongoing reform momentum, and a significant fiscal pivot that includes plans for €1 trillion in new debt by the end of the decade. The strategists also made two key sector rating changes:

• Utilities: Upgraded to Overweight. The bank views the sector's recent rate-driven selloff as "unjustified," given its low historical correlation to rising rates and earnings estimates that have not yet factored in a recent rebound in power prices.
• Health Care: Downgraded to Neutral, with the bank seeing better risk-reward opportunities in other defensive sectors like Staples and Real Estate.

Macro Backdrop Is Key

Historically, equities have shown resilience to rising bond yields when the underlying economy is strong. The strategists pointed out that when the 10-year U.S. Treasury yield has crossed 5% in the past, the S&P 500 was, on median, flat on the day and up nearly 1% one month later.

Looking ahead, Deutsche Bank forecasts 3-6% upside for major European indices by the end of 2026. The bank also projects 15% earnings growth for the STOXX 600 index this year.