UBS says stocks still have 5-10% to run, but watch out for this level of return

A sign of Swiss banking giant UBS is seen at a branch in Zurich on October 26, 2018.

Fabrice Coffrini | AFP | Getty Images

UBS Global Wealth Management predicts a 5% to 10% increase for global equity markets, emerging markets, financials, energy stocks and small caps being best positioned to capitalize.

In a monthly investment call on Tuesday, UK CIO Caroline Simmons said analysts have a particular preference for emerging markets in Asia and China in particular. It has also supported cyclical and value stocks – those whose performance will coincide with the economic recovery or those whose valuations are lower than their financial position would justify.

This is based on forecasts that the economic recovery will broaden and accelerate during the year, continuing to support a rotation from high-growth sectors such as technology to sectors that benefit from an acceleration in the economy. industrial production and rising inflation.

“Small caps tend to be more cyclical in terms of sector makeup than large caps, so they are more convergent towards the economic recovery and their valuations remain attractive,” Simmons said on the call.

“The price / book ratio of the MSCI Small Cap (index) compared to the MSCI World is nearly two standard deviations below the long-term average, so small caps, although they have performed quite well since November, remain attractively priced. “

She noted that financials had underperformed the S&P 500 by around 5% since the end of 2019, but have recently started to make a comeback as the value rotation and inflation expectations accelerate.

A recent rise in the benchmark 10-year US Treasury yield and other bond yields around the world triggered equity market volatility as investors began to question valuations in growth sectors sensitive to higher interest rates.

The 10-year rate was hovering around 1.6209% Thursday morning in Europe, but UBS expects it to hit around 2% by the end of the year.

“Higher yields and steeper yield curves are generally more useful to financials. They help their net interest margins and they also generally see improvement in non-performing loans,” Simmons said.

She added that financial profits would be beneficial if provisions for bad debts were found to be excessive relative to the reality of loan losses, while valuations remained low relative to the rest of the market.

Meanwhile, energy stocks, from the Tuesday afternoon call, had no S&P 500 around 33% since the end of 2019, and UBS believes there is considerable room for catching up. The Swiss lender expects Brent prices to hit $ 75 a barrel by the end of the year, and Simmons noted that energy companies offer strong cash flow and dividend yields.

International benchmark Futures on Brent traded at $ 63.60 Thursday morning.

Bond yield break

While the rise in bond yields caused some nervousness in the market, Simmons argued that a continued rise would not necessarily mean the end of stock gains.

“In the past 25 years, there have been 10 periods in which the 10-year Treasury yield has risen by more than 100 basis points, and in all of these cases, global equities have produced stable or positive returns. “, she underlined.

In a letter to investors on Monday, Mark Haefele, CIO of UBS Global Wealth Management, noted that rising inflation expectations also tend to reduce risk premiums on equities, while adding that “other things being equal. elsewhere, higher yields present a headwind for equity valuations.

Haefele pointed out that despite rising yields, current valuations are above the long-term average risk premium on equities. An equity risk premium is the return generated on a particular asset above the risk-free rate of return.

“We don’t think inflation or yields are a risk. What I will say is that if yields rise significantly, maybe above 2.25% in the US, it potentially starts. to have implications for stock valuations, then it would become a discussion of whether earnings growth is strong enough to offset a valuation impact or not, ”Simmons said.

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