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Both defensive and cyclical stocks are vulnerable, Deutsche Bank says

Market volatility returns

Equity market investors may find few ports in the storm in the coming months, as safe-haven stocks and those that typically rise and fall with the business cycle look vulnerable, Deutsche Bank strategist David Bianco said Wednesday.

Deutsche Bank is betting the volatility that has crept back into markets continues and thinks an 8 to 10 percent S&P 500 dip is in the cards. In a note Friday, the bank said volatility will be stoked by cuts to 2017 earnings expectations, uncertainty over interest rates and the election, and a sluggish recovery in capital spending.

Now, the rise in long-term U.S. bond yields has upended a popular trade that saw investors pile into stable, income-generating defensive stocks during a period of persistently low interest rates. Major U.S. averages closed down more than 1 percent on Tuesday as the U.S. 10-year Treasury yield rose above 1.7 percent to its highest level since June.

"That has caught a lot of investors who thought long-term yields would never go up off guard, hurting things like utilities, telcos, REITs — the bond substitutes," Bianco said on CNBC's "Squawk Box."

"That's been a challenge in the market, and we're going to be guessing all year long and well into next year as to where the Fed will be and where long-term yields will be, and that volatility will stay with us."

But investors cannot count on cyclical stocks either, making this a difficult market to navigate, said Bianco, Deutsche Bank's chief U.S. equity strategist. He sees considerable downside risk to investing in industrials and energy stocks.

"We're not seeing the acceleration in investment spending, or export activity, or industrial activity to justify where industrial companies are trading, or the kind of pace of recovery in oil prices to justify where energy stocks are trading," he said.

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