Stocks set for upside as AI bets, rate cuts add steel to offset rising yields

Investing -- The sharp rise in Treasury yields have been flagged as headwind for stocks, but analysts at UBS believe that ongoing Federal Reserve rate cuts and the promise of artificial intelligence may provide a cushion for stocks to continue their bullish run.

"Historically, stocks have performed well in years when the Fed has been cutting rates while the US economy is not in recession," analysts at UBS said in a recent note.

The bullish backdrop for stocks come even as yield on 10-year US Treasuries climbed 60 basis points since the start of October. Rising Treasury yields are usually cause for concern for equities investors as attractive yields tend to present an alternative to stocks while also lowering the current value of future cash flows.

But the S&P 500 hardly flinched and remains about 2% below its recent record high because the reason why yields are rising matters, the analysts said.

When yields rise on concerns about elevated inflation prompting rate hikes from the Fed - as seen during 2022 - stocks typically face headwinds. But this latest jump in yields is different -- and is likely to decline.

"While markets have been anticipating slightly higher inflation in the wake of Donald Trump’s election victory, much of the rise in yields has been driven by hopes of stronger economic growth," they added.

The hit to future cash flows from a higher discount rate, meanwhile, have been offset somewhat by optimism over the commercialization of AI. 

"Markets have been revising up expectations for cash flows—more than offsetting a slightly less favorable discount rate," the analysts said, forecasting further upside for the S&P 500. 

"[W]e expect the S&P 500 to reach 6,600 by the end of 2025, around 12% higher than the level at the time of writing," they added.

Source: Investing.com