Stock investors are underestimating the risk of war and focusing too much on a recession that's unlikely to happen, a Wall Street investment chief says

• The potential for Russia to ramp up its war against Ukraine is the top risk to the stock market, according to investment firm DWS.
• The war could spur another spike in oil prices, which soared after the invasion began in late February.

Inflation at a four-decade high and a possible recession are the top concerns among equity investors, but the risk of Russia ramping up its war against Ukraine should be their biggest worry, said the head of Americas investing at German asset manager DWS Group.

Recession, high inflation, excessive valuation, and war are the four major long-time worries that usually trigger bear markets, David Bianco, chief investment officer for the Americas at DWS Group, said in a note to clients published this week.

"We're concerned about all of these threats and stay cautious on the S&P 500 near-term, but rank our worries in this order: 1) escalating war (higher oil), 2) European recession, 3) non-commodity wage-spiral inflation, 4) excessive valuation," he said.

The warning comes as a top Russian general on Friday made one of the first and most explicit descriptions of the country's plans for its war against Ukraine, saying a top goal is to conquer Ukraine's eastern Donbas and southern regions.

DWS is watching the war as an escalation could lead to another surge in oil prices, and eventually, to a recession. Prices of Brent crude, the international benchmark, and West Texas Intermediate crude shot up to highs not seen since 2008 after Russia invaded Ukraine in late February. The surge quickly pushed US gas prices to near-record highs of more than $4 a gallon.

If any recession were to take place, "we think it stems from Europe," said DWS. The euro area is facing pressure from higher energy prices as the region relies heavily on Russian oil and other natural resources. The International Monetary Fund this week said the war was interrupting the global economy's recovery from the COVID crisis and slashed its 2022 euro-area growth forecast to 2.8% from 3.9%.

As more evidence of Russian war atrocities emerges from Ukraine, the European Union has moved closer to a full Russian oil embargo, which JPMorgan has said could send oil flying up to $185 a barrel. Brent crude on Friday traded at around $106 a barrel.

Meanwhile, Bianco said it's unlikely that monetary policy tightening by the Federal Reserve will tip the US into recession this year or next. The Fed last month launched what's expected to be an aggressive cycle of interest rate hikes to cool inflation that in March accelerated to 8.5%.

With US recession risks subdued, DWS said its preferred cyclical exposure is to banks and small-cap stocks. Banks can make money on the back of higher interest rates on loans, and small-cap stocks represent companies that are more exposed to economic developments.

"We consider Health Care the most attractive sector, then Communications (decent earnings growth dependent) and then Financials (no US recession dependent)," said Bianco. "Our preferred defensives are Utilities and Real Estate Investment Trusts (REITS), but we've reduced our over-weights at both."