National Bank Financial sketches out three different scenarios for the economy and markets in the year ahead, in a new report.

NBF indicates that the performance of capital markets over the next 12 months will depend on what type of landing is in store for the U.S. economy and on the direction of oil prices, among other factors. Given the uncertainties involved, it offers three different scenarios.

Under the Goldilocks scenario, the U.S. Federal Reserve Board is on the eve of going to the sidelines but earnings will continue to post decent growth. “In previous mid-cycle episodes (mid-1960s, mid-1980s, mid-1990s), the U.S. stock market actually rose almost 20% on average in the 12 months following a pause or a shift in Fed policy,” it says. “In this scenario, the 12-month target for the S&P 500 should be 1500 (13500 for the S&P/TSX assuming a new oil price equilibrium at $65).” It puts the probability of this at just 15% however.

At the other end of the spectrum is the spectre of a classic consumer-led recession. “In this scenario, the price of oil is driven even higher by Mideast geopolitical tensions and a U.S. housing bust. U.S. earnings drop 20% to 25% over the next two years, led by a credit crunch in the financial sector,” it says. The S&P 500 would likely move to 1100, and the S&P/TSX sooner or later falls to 8500, “as bank loan losses surge and demand for commodities plunges with unwinding hedge funds positions”. It attaches a 25% probability to this scenario.

Finally, the economy could experience prolonged sub-par GDP growth. “The U.S. economy, after posting the best growth sequence in 20 years (10 quarters in a row above 3%), is likely to suffer from tougher lending standards for real estate and a lack of fiscal or monetary stimulus (savings rate currently negative). In the past, a rising output gap has been followed by negative earnings revisions,” it notes. “In this scenario, the S&P 500 returns to 1250 and the S&P/TSX drops to 10500 on a better equilibrium of supply and demand for commodities.” This is NBF’s baseline scenario, with a probability of 60%.