Q4 market outlook

Analyzing investment opportunities in this all-time-high stock market.

16 Sep 2021

At a glance

"Our outlook for Q4: Navigating record highs" is the continuation of the series where UBS Chief Investment Office provides quarterly updates on the investment outlook.

In this edition, we explore six investment topics on how investors should position in the short- and long-term.

Navigating record highs

Global equities have rallied to new highs in the third quarter of 2021, powered by strong economic and corporate earnings growth, particularly in the US and Europe. Unusually, this has coincided with a sharp fall in bond yields, with the US 10-year yield dropping as low as 1.2%, and US high yield bonds now trading at around 4.4%.

In the near term, we expect growth to remain strong—we forecast global growth of 6.2% in 2021 and 5.1% in 2022—and monetary policy to remain loose. The Federal Reserve, which is likely to announce its plans to taper quantitative easing in the fourth quarter, has been at pains to stress it will remain data dependent, and that the start of tapering does not imply any particular timeframe for interest rate increases.

This creates a supportive fundamental backdrop for equities, and we continue to recommend investors to buy into markets and sectors best positioned to win from this period of high global growth, such as Japanese equities, energy, and financials. At the same time, with interest rates and bond yields at low levels, fixed income investors face a dearth of yield, and higher levels of potential return are only available in alternative areas such as private credit and real estate, through volatility-selling strategies, or through more active approaches to the asset class.

Of course, a backdrop of global equities at record highs and interest rates at record lows is an uneasy one for many investors, and debates about the path by which the global economy returns to “normal” will contribute to volatility, even if the Fed has committed to managing this process carefully. The spread of the coronavirus delta variant, China’s regulatory crackdown, and geopolitical uncertainties all present additional risks. With this in mind, investors should review the potential benefits of diversifying portfolios to include alternatives such as hedge funds, private markets, and structured investment strategies. All have alternative payoff structures and so can help improve diversification and overall risk-return profiles. 

Six key topics to help you prepare your portfolios

We are likely past the peak in year-on-year GDP growth rates, but growth and inflation are likely to stay elevated, thanks to consumer spending, retailer restocking, and monetary and fiscal stimulus measures. This should drive ongoing robust earnings growth: We are looking for 42% growth in global corporate earnings this year and 9% in 2022. We think this is a good environment for equities overall, and in particular for the energy and financials sectors, US mid-caps, and companies exposed to economic re-opening. In contrast, we see limited upside for sectors like industrials, real estate, and consumer staples.

The substantial fall in bond yields and the compression in credit spreads in 2021 mean that the opportunity set in public bond markets is now limited, and even “high yield” credit has only limited return potential in the US and Europe—although the outlook for Asia is still positive, in our view. Investors holding cash or traditional bonds but looking for additional income now should consider alternative means of yield generation, across private credit, senior loans, active fixed income, direct real estate, and FX, or by employing leverage or volatility-linked strategies.

With bond yields at low levels, portfolio diversification is an increasing challenge for investors, particularly against a backdrop of global equity markets at all-time highs, and emergent risks including the delta variant, China regulations, and geopolitics. Investors looking to diversify sources of risk and return should consider both hedge funds and private markets, as well as structures that can deliver alternative payoff profiles.

We think the healthcare sector offers an attractive combination of defensive and long-term growth features, combining relatively inelastic demand and attractive long-term structural drivers. The sector tends to outperform after economic indicators peak. Pharmaceuticals are the most defensive industry within the sector, while medtech stocks are more geared to the post-COVID-19 recovery. Transformational themes such as healthtech and genetic therapies provide exposure to longer-term structural growth. We think investors should include all of them in their portfolios.

Global markets have been hitting all-time highs, and so have global temperatures, with July the hottest ever month on record on Earth. Policymakers are taking note and the transition to carbon net zero is continuing. This should continue to benefit companies developing greentech and clean air solutions, as well as creating new opportunities in carbon markets. These strategies are all part of a broader shift toward sustainable investing—our preferred approach for investing globally.

Beyond healthcare and sustainability, the digital transformation of sectors ranging from transport to manufacturing and financial services continues. We see particular opportunity in smart mobility and automation, in those companies benefitting from the growth in the digital asset universe, and in cybersecurity, a key enabler of automation and digitalization.

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