HSBC: The stock market is pricing in "recession" rather than "stagflation", creating oversold opportunities in emerging markets.

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Global stock markets are processing the impact of the Middle East conflict with a recession logic. HSBC strategists believe that the sharp sell-off has created buying opportunities in some emerging markets.

HSBC strategists Alastair Pinder and Pankaj Agarwala pointed out in a report on Tuesday that since the outbreak of the Middle East conflict at the end of February, market panic triggered by surging oil prices has raised the probability of global stocks pricing in a recession from 10% two weeks ago to 35%. Meanwhile, the probability of pricing in stagflation is only 8%, with almost no significant change. This divergence indicates that the current sell-off logic in the markets aligns more with recession trades, rather than the stagflation scenario reminiscent of the 1970s that most investors worry about.

The two strategists stated that despite heavy selling pressure, some markets have become oversold and mispriced, providing attractive entry points for investors. They named South Korea, South Africa, and Indonesia as markets oversold by about 5% to 10%; the UAE's Dubai and Abu Dhabi markets are undervalued by about 10% compared to fundamentals, although the latter's discount partly reflects geopolitical risk premiums.

Since the end of February, global stock markets have dropped about 5% cumulatively. Continued volatility in oil prices has fueled investor concerns over stagflation risk, with cyclical sectors trailing defensive sectors by about 9%.

Recession pricing dominates, stagflation narrative exaggerated

HSBC strategists differentiate clearly between stagflation and recession market scenarios in their report. Despite growing discussions about a "turn to stagflation", Pinder and Agarwala believe the actual performance of the stock market is signaling something different.

"Our mechanism model shows the current probability of recession priced into the market is 35%, a sharp rise from 10% two weeks ago, while the implied probability of stagflation has barely moved and remains at 8%," they wrote in the report.

This data difference suggests that market participants do not really believe that stagflation will become the dominant scenario, and that selling behavior reflects more concerns about a sharp slowdown in economic growth.

Opportunities from mispricing in South Korea, South Africa, Indonesia and Gulf markets

At the market level, HSBC used a machine learning system to calibrate the decline in various markets against their fundamentals, identifying several oversold opportunities.

South Korea, South Africa, and Indonesia were determined to be oversold by about 5% to 10%. HSBC notes that these three markets have relatively low exposure to rising oil prices, making their current valuations particularly attractive. The Korean Kospi index was once the best-performing global stock market in 2025, but after the conflict broke out, it suffered severe fluctuations due to concentration in memory chip giants and sensitivity to energy prices.

In the Gulf region, UAE stock markets have been under pressure since reopening after a brief closure. HSBC estimates that Dubai and Abu Dhabi stocks are undervalued by about 10% compared to fundamentals. However, strategists caution that this gap "likely reflects the geopolitical risk premium embedded in current stock prices," and investors should take this into account.

In contrast, the declines in Norway, Saudi Arabia, Malaysia, and Singapore's stock markets are less than what could be explained by macroeconomic shocks, indicating that these markets have not yet fully reflected fundamental downgrades.

Cyclical stocks favored over defensive stocks

At the industry allocation level, HSBC strategists suggest looking for defensive characteristics within cyclical sectors, rather than a broad shift to defensive sectors.

"We prefer cyclical sectors that remain resilient in a stagflation environment," Pinder and Agarwala said. "Overall, we believe materials, industrials, and financials are in relatively advantageous positions."

In contrast, HSBC lists retail, travel and leisure, and media as the "biggest losers" in a stagflation environment, believing these sectors are most vulnerable under the dual pressure of shrinking demand and rising costs.

Risk warning and disclaimerThe market involves risks, and investment should be done cautiously. This article does not constitute personal investment advice and has not considered the individual investment objectives, financial situation, or needs of any specific user. Users should consider whether the opinions, viewpoints, or conclusions in this article are suitable for their particular situation. Invest accordingly at your own risk. ```