HSBC: The stock market is pricing in a "recession" rather than "stagflation," and there are oversold opportunities in emerging markets

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

HSBC strategists Alastair Pinder and Pankaj Agarwala pointed out in a research report on Tuesday that since the outbreak of the Middle East conflict at the end of February, the market panic triggered by soaring oil prices has pushed the probability of a recession priced into global stock markets from 10% two weeks ago to 35%. Meanwhile, the probability of stagflation is only 8%, showing almost no significant change. This divergence indicates that the current sell-off logic in the market is closer to a recession trade rather than the stagflation scenario that the market widely fears reminiscent of the 1970s.

The two strategists stated that despite heavy selling pressure, some markets have shown oversold mismatches, providing attractive entry opportunities for investors. They specifically noted that the stock markets in South Korea, South Africa, and Indonesia have been oversold by about 5% to 10%; the valuations of the stock markets in Dubai and Abu Dhabi are undervalued by about 10% relative to fundamentals, although the latter discount partially reflects geopolitical risk premiums.

Since the end of February, global stock markets have fallen by about 5%. The continued volatility in oil prices has heightened investors' concerns about stagflation risks, with cyclical sectors significantly lagging behind defensive sectors by about 9%.

Recession pricing dominates the market, stagflation narrative is exaggerated

HSBC strategists clearly distinguish between stagflation and recession scenarios in their research report. Although discussions about a "shift to stagflation" are increasing, Pinder and Agarwala believe that the actual performance of the stock market conveys a different signal.

"Our mechanism model shows that the current recession probability priced into the stock market is 35%, a significant increase from 10% two weeks ago, while the implied probability of stagflation has hardly moved, remaining at 8%," they wrote in the report.

This data discrepancy indicates that market participants do not genuinely believe that stagflation will become the dominant scenario; the sell-off behavior more reflects concerns about a sharp decline in economic growth.

Oversold opportunities in South Korea, South Africa, Indonesia, and Gulf markets

At the specific market level, HSBC identified multiple oversold opportunities by calibrating the declines in various markets through a machine learning system.

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

In the Gulf region, the UAE stock market has continued to be under pressure since it resumed trading after a brief suspension. HSBC assessed that stocks in Dubai and Abu Dhabi are undervalued by about 10% relative to fundamentals. However, the strategists cautioned that this gap "likely reflects the geopolitical risk premium embedded in current stock prices," which investors need to take into account.

In contrast, the stock markets in Norway, Saudi Arabia, Malaysia, and Singapore have experienced declines below the levels that macroeconomic shocks can explain, indicating that fundamental downgrades have not been fully reflected in the market

Cyclical Stocks Outperform Defensive Stocks

In terms of industry allocation, HSBC strategists suggest looking for defensive attributes within cyclical sectors rather than fully shifting to defensive stocks.

“We tend to favor those cyclical sectors that remain resilient in a stagflation backdrop,” Pinder and Agarwala stated, “Overall, we believe that materials, industrials, and financials are in a relatively favorable position.”

In contrast, HSBC lists retail, travel and leisure, and media sectors as the “biggest losers” in a stagflation environment, believing these sectors are the most vulnerable under the dual pressures of demand contraction and rising costs