UBS says lows are not in, S&P 500 will fall to 3,200
According to UBS, stocks still have a long way to go to bottom. The bank said Monday that the S&P 500 will end in the second quarter of 2023 at around 3,200. That’s 15% below where the index closed last week. “Downgrades are not in,” UBS economist Arend Kapteyn said in a note to clients. He noted that the economy has yet to feel “the full effect of the rapid recalibration of monetary policy.” The economist also said the U.S. is likely to experience an economic contraction in 2023 that will be at the “mild” end of the historical range. Another source of pressure will be weak earnings. All of this could give way to a disinflationary environment where rates fall, leading to a market bottom and paving the way for a disinflationary environment. That will lift the S&P 500 to 3,900 by the end of 2023, Kapteyn said. How to play the ‘disinflationary environment’ In what UBS calls a “disinflationary environment” expected around the world next year, Kapteyn recommends more exposure to health care, communications services and technology. Health and communications services tend to do better than other sectors during periods of declining inflation and feel less of an impact from changes in inflation, he said. Meanwhile, income from information technology and health care is considered the least correlated to changes in the inflation index used by UBS. Specifically within the US, Kapteyn said investors should take advantage of the fact that compensation tends to be more “resilient” than business investment spending during a recession, looking at consumer discretionary and staples rather than industrials and materials. He also said that quality and growth stocks will outperform value as the latter’s structural challenges become more apparent in times of slower growth. With these themes in mind, UBS has compiled a list of US stocks that will be most positively affected by falling inflation. The list ranges from big tech names like Netflix, which took losses after a largely disappointing earnings season, to biotech stocks Incyte — which posted a small gain despite the S&P 500 falling into a bear market. UBS looked at how each stock’s returns correlate with inflation, how inflation compares to forward sales, and average monthly performance compared to the six-month inflation trend. Using this data, the company created a composite score to find the stocks most likely to rise as inflation eased. Of the more than 30 stocks listed by UBS as potential winners, the average composite score was 0.83. UBS also listed the stocks that will be hurt the most by lower inflation. Also on the list is the oil company Exxon Mobil, which is considered one of the winners in 2022 with an increase in the value of shares of 85.6% this year. How other markets will move Kapteyn also recommended going long on 10-year US Treasuries with falling inflation and a weaker economy. Treasury yields have jumped in recent weeks in response to interest rate changes by the Federal Reserve and other central banks around the world. He said the risk-return on US Treasuries is “very attractive for the first time in more than a decade if inflation remains stable and the labor market remains robust.” There is also an “attractive entry point” on the yield curve between the 5-year and 30-year bonds, he said. The movement of currencies and commodities is also expected in response to a period of falling inflation. The US dollar is likely to fall lower against the yen and euro after surging this year and biting into the foreign earnings of multinationals. Meanwhile, after a tough year, 2023 should be “the year for gold,” he said, with the risk-reward ratio looking attractive on expectations that the Federal Reserve will be less hawkish about inflation and lower interest rates in the second half of the year. True, he noted that this scenario is in some cases driven by “luck” and can be considered “broadly optimistic” because it is based on falling food and energy prices and cost pressures that are increasingly being absorbed into the company’s bottom line as opposed to passed on to consumers. Kapteyn also said it is impossible to explain events that can drastically change the landscape, pointing to the Russian invasion of Ukraine as an example. He said a global housing slump, China’s 2 percent economic growth, steady inflation or a rapid slowdown in the Russia-Ukraine war are potential shocks that are hard to predict but could affect markets in 2023. – CNBC’s Michael Bloom contributed reporting.
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