Stock markets are in for a wild ride next year as they don't yet reflect the risk of a U.S. recession, according to strategists at Goldman Sachs Group Inc. and Deutsche Bank.

The team, including Christian Mueller-Glissmann and Cecilia Mariotti, said their model implies a 39% probability of a U.S. growth slowdown in the next 12 months, but risk assets are only pricing in an 11% chance. "This increases the risk of further recession scares next year," they wrote in a note on Monday.

Deutsche Bank's Binky Chadha, meanwhile, expects the S&P 500 Index to slump to 3,250 points, 19% below current levels, in the third quarter as a recession begins, before rebounding in the fourth quarter.

Their calls are a warning after equities rallied sharply in the past two months on bets that a peak in inflation will lead to a softening of hawkish central bank policies. The Goldman strategists said that while monetary policy should become less of a headwind next year, slowing global growth will keep stocks under pressure.

"Equity risk premia appear low considering elevated recession risk and uncertainty on the growth/inflation mix," the Goldman strategists wrote, with stock drawdown risk higher amid weak growth and volatility, coupled with high valuations. The S&P 500 trades at 17.5 times its forward price-to-earnings ratio, above its 20-year average of 15.7 times.

Goldman's analysis shows that equities tend to rebound once inflation has peaked if a recession is avoided. In the event of a contraction, however, they decline another 10% on average in the six to nine months after the peak. While they see U.S. recession risk as relatively low, they noted that concerns over financial stability as well as market stress indicators, such as liquidity risk and solvency risk, has increased across asset classes.

Overall, they prefer bonds over stocks, saying they offer better risk/reward and should be less positively correlated with stocks later in 2023.

The Goldman strategists estimated last week that the S&P 500 will end 2023 at 4,000 index points, nearly unchanged from Friday's close. They expect higher volatility going into next year followed by a recovery in the second half, they said on Monday. Deutsche Bank's team also predict a rebound for the index in the fourth quarter, ending the year at 4,500 points.

Among Goldman's other calls, the strategists said:

• Remain "relatively defensive" over three-month horizon; overweight cash/credit, neutral commodities and underweight bonds/equities.
• Focus on yield in near-term; like high-quality credit and selective on procyclical assets.
• Expect opportunities to add risk in 2023; neutral across assets and overweight commodities over 12-month timeframe.

After the recent revival in stocks, cracks are starting to appear as sentiment turns negative, in part driven by China's increasingly messy COVID-zero exit strategy, and threatening the equity market's November momentum.

Timing is most inconvenient here, as the S&P 500 approaches a crucial technical resistance line at its 200-day moving average. Should the recent bullishness evaporate, short-term tactical bear trades might spark a bout of profit taking.

Contracts on the S&P 500 and Nasdaq 100 were down Monday morning, extending Friday's decline following the Thanksgiving holiday. Growing unrest in China over COVID restrictions and manufacturing snags sent oil companies, Apple Inc. and U.S.-listed Chinese shares lower.

Sagarika Jaisinghani and Norah Mulinda report for Bloomberg News.

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