Equities can withstand recent rise in yields, says UBS

Investing.com -- US Treasury yields moderated recently, with the yield on 10-year notes retreating from an intraday peak of 4.5% to approximately 4.38% at market close.

Still, the yield remains 60 basis points (bps) up since the start of October. According to UBS strategists, such a rapid increase in yields “might be expected to be a problem for equities, presenting investors with an increasingly attractive alternative to stocks and lowering the current value of future cash flows.”

Nevertheless, the S&P 500 index has maintained a strong position, remaining within 2% of its record high from last week. UBS suggests that while rising yields traditionally pose a challenge to equities, there are “several reasons why equities can withstand the most recent move.”

UBS notes that the context behind the yield rise is crucial. Unlike previous increases driven by inflation fears and aggressive rate hikes by the Federal Reserve, the current uptick has been fueled by expectations of stronger economic growth, following a trend that began in October, when the resilience of US data surpassed investor expectations.

The bank also points out that the speed of the yield increase has not yet disrupted the equity market.

They estimate that monthly hikes in the real 10-year yield exceeding 40 basis points might increase volatility in stocks; however, the October rise was 36 basis points, slightly below this threshold.

“The momentum of rising yields also slowed in November. We also believe that the increase in US Treasury yields has gone too far, and our base case is for a decline,” UBS strategists said in a Wednesday report.

They also point out that the market's enthusiasm for AI has helped mitigate the impact of higher yields.

Traditionally, tech and growth stocks are more sensitive to yield fluctuations due to their future profit expectations. However, the market's bullishness on AI's commercial potential has led to revised cash flow expectations, which have offset the effects of rising yields.

“While enthusiasm for AI is no longer new, it has contributed to the resilience of markets overall, in our view,” strategists continued.

Overall, UBS maintains a positive outlook for equities, predicting the S&P 500 will reach a target of 6,600 by the end of 2025, which would mark approximately a 12% increase from current levels.

The firm recommends maintaining diversified exposure to Asia excluding Japan and identifies attractive investment opportunities in European small- and mid-cap stocks, as well as Swiss high-quality dividend stocks.

Source: Investing.com