UBS Explains: Equities (11:46)
CIO's co-head of global asset allocation Mark Andersen explains how to invest in equities over the cycle and how we see the outlook for the remainder of 2023.

Thought of the day

The S&P 500 rose 0.3% on Tuesday, taking its 2023 gain to 19%, amid hopes that the Federal Reserve’s expected 25bps rate hike today might be the last of this cycle. Fed funds futures are now implying a less than 50% chance the US central bank will raise rates again after this meeting. The mood for equity investors was further improved by positive US economic data, with the Conference Board’s consumer confidence index hitting a two-year high in July.

But investors should beware of becoming too optimistic that today will mark the end of the rate-hiking cycle, in our view.

The Federal Reserve will remain eager to stress its inflation-fighting credentials. Inflation data for June came in below expectations, with the core measure that excludes food and energy rising 4.8% annually, versus a consensus estimate of 5%, and down from the peak of 6.6% in September. Despite this encouraging news, top Fed officials have repeatedly warned against prematurely declaring victory on inflation. At last month’s meeting, Chair Jerome Powell said that “the process of getting inflation back down to 2% has a long way to go.”

An abrupt turn on the basis of a single month of positive data looks unlikely, especially given the core rate remains well above the Fed’s 2% target. The Fed will also remain alert for warning signs that expectations for higher inflation are becoming entrenched. The median inflation expectation among consumers for five years from now rose by 0.3 percentage points in June to 3%, the highest reading since March 2022, based on the latest New York Fed survey.

The dot plot, which tracks the rate predictions of top officials, continues to point to a further rate hike after today’s meeting. While the Fed has scaled up its outlook for rate hikes through the cycle in response to higher-than-expected inflation, the central bank has been consistent in delivering on its updated guidance. In contrast, markets have tended to be too optimistic that the Fed will end hikes earlier than officials have been signaling. Based on this track record, our view is that investors should avoid becoming complacent about an end to rate increases. Federal Reserve Governor Christopher Waller said earlier this month he saw two more 25-basis-point hikes for the remainder of 2023 as being “necessary to keep inflation moving toward our target.”

Incoming data still has the potential to disappoint ahead of the Federal Reserve’s next meeting, which is not until 19–20 September. In the meantime, two more consumer price index readings and two more monthly employment updates will be released. While we expect further signs of cooling inflation and jobs growth, risks remain that the data will surprise in a way that will encourage Fed officials to follow through with an extra 25bps increase.

The Fed will also remain alert for other indications that rate hikes have not had a sufficiently cooling effect on the economy. On Tuesday, there was further evidence of resilience in the rate-sensitive housing market, with the S&P CoreLogic Case-Shiller index up by 1% over the month, versus an expected gain of 0.7%. That was the fastest monthly house price growth in a year.

So, while recent signals have been pointing to a positive combination of slowing inflation and a resilient US economy, risks remain. Against this backdrop, we see greater upside for fixed income relative to equities, which are already priced for a benign economic outcome. The rise in yields in recent months provides a good opportunity for investors to put excess cash to work. The more defensive, higher-quality segments of fixed income look most appealing to us, given the all-in yields on offer and the potential for capital appreciation as investors shift their focus from inflation risks to growth risks.