Her Eleftherias Kourtalis
The recent rally in stocks, especially in July, caught many investors by surprise as markets rebounded despite aggressive central bank interest rate hikes, soaring inflation, energy turmoil in Europe, a new housing crisis in China and the war in Ukraine. which has shown no sign of ending.
The improved risk appetite was largely based on the view that the Fed may back off from rapid rate hikes amid signs of softer US economic data, UBS explained. Better-than-expected second-quarter corporate earnings for the S&P 500 also bolstered positive sentiment in recent weeks.
The S&P 500 climbed 9.1% in July, erasing June’s losses, and the MSCI All Country World index rose for the first time in five months to gain 6.9%. Both indices posted their biggest monthly gains since November 2020.
“However, we advise investors not to get too excited by July’s somewhat more positive picture. We believe there is too much uncertainty and markets may remain volatile in the coming months“, warns the Swiss bank.
The time until September is long
There are almost two months of economic data between now and the Fed’s next meeting on September 20-21 for markets to digest, UBS points out. Economic data releases have become critical after Fed Chairman Jerome Powell said the September decision will depend on them. Despite two quarters of economic contraction, the Fed will want to see concrete signs of easing inflationary pressures, especially in the labor market.
What’s more, UBS adds, this latest round of tightening is unusual because the Fed has been slow to raise interest rates and may continue to do so even after a recession begins. Furthermore, current labor market conditions are unprecedented: the US economy experienced what the financial press is calling a “technical recession” in the first half of 2022, yet job growth was rapid. While falling commodity prices and a softening housing market, among other factors, suggest that inflation should moderate next year, if that is enough to reduce price pressures without at least a percentage point increase in the unemployment rate, it is debatable.
US-listed earnings results so far have been broadly satisfactory and largely in line with the Swiss bank’s expectations. However, estimates are declining. Based on the S&P 500’s 12% rally since the June low, it’s now clear that investors are bracing for a more disappointing outlook.
At the same time, consumer spending is holding up well but there are clear shifts away from certain goods (clothing, computers) and housing in favor of travel, energy and food. Lower-income households are feeling most of the inflationary pressures, and a strong dollar is a major headwind for multinationals.
“At current levels, we believe the S&P 500 is within their fair value range for a soft landing scenario. Equity markets could move a bit higher as inflation continues to decline, but profitability will also continue to slow.” It is difficult to see significant upside in stocks in the near term, unless there is a very significant reduction in inflation coupled with a re-acceleration of economic growth. Therefore, for now, year-end and June 2023 S&P 500 targets are 3,900 and 4,200 points respectivelya”, notes UBS.
Triple threat: US economy slows, China experiences housing crisis, Europe teeters on recession
The global economic outlook remains bleak, as the Swiss bank emphasizes. The US economy contracted for two consecutive quarters. However, the Fed may not necessarily be worried. As Powell said at the last policy meeting, “we think we need a period of growth below momentum in order to create some slack so that the supply side can be met.”
Alongside, Europe is on the brink of recession, as its energy crisis looks set to worsen in the coming months, with the prospect of further disruptions to Russian gas supplies and the possibility of reduced winter energy consumption.
In addition, China is set for a bumpy landing of its economy in the second half due to its zero COVID-19 policy and an unexpected crisis in the real estate sector.
Therefore, based on all these risks, UBS remains neutral on the stock and advises investors not to get carried away by the recent rally. He expects markets to remain fairly volatile until the overall effects of more aggressive central bank policies become clearer.. Thus he favors “value” stocks over “growth” stocks which are still expensive in relative terms and negatively correlated with increase in real interest rates, while at a sectoral level, it still favors energy and healthcare.