UBS Analysts Argue Market Risk Aversion May Be Overdone
According to UBS, a well-known investment bank, the market's recent reaction to events has been excessive. Here's a breakdown of why they think the fear might be over the top, even with some big events shaking things up in the macroeconomic landscape.
Recent Market Drops
European Equity Index Drop: The European equity index, called SXXP, dropped by 7% from its peak in May. Certain sectors, such as France, Luxury, Consumer Services, Semiconductors (Semis), and Media, have fallen back to levels we saw in January 2024.
Why UBS Thinks the Reaction is Too Much
UBS analysts argue that the data wasn't all that bad. They suggest that the recent market drop might also be due to Hurricane Beryl affecting the numbers.
Incrementally Negative Data: The information was only a little bit negative, and other external factors may have exaggerated the reaction.
Low Stock Correlation and Rising Volatility: The market's sharp decline also looks like an overreaction because stocks are not moving together (low correlation) and volatility (price swings) are increasing.
Forced Selling and Its Effect
When stock prices fluctuate a lot (rise in volatility), certain funds start selling to maintain a steady volatility level.
- Forced Sellers: These are funds that react to volatility by selling off their stocks, creating a heavier risk premium – essentially making investments appear riskier than they might actually be.
Past Experience as a Guide
UBS brings up an example from 2018 to make their point. After the market dropped by 20%, the US Federal Reserve quickly changed its restrictive policies, resulting in a swift market rebound.
- Historical Precedent: This past experience suggests that the current market fears might also be overblown, leading to another gradual recovery.
Opportunities and Predictions
'Quality' Stocks
According to UBS, even in these uncertain times, there's a solid opportunity in 'quality' stocks, which are known to perform better under volatility.
- Examples: Some companies like RELX (a data analytics company) and ASML (a semiconductor manufacturer) are expected to outperform as they have in similar scenarios.
Utilities Sector
Another sector to look at is Utilities. UBS sees a promising future for European utilities due to their growth on modest valuations.
- Example: European utilities did well towards the end of 2018, showing resilience in tough times.
Bullish Outlook
UBS is feeling positive about the future, predicting that Buy-rated stocks could give average total returns of 26%. This means an optimistic view on stocks they've labeled as good investments.
Terminology Explanation
Volatility: How much stock prices go up and down. If prices change rapidly, volatility is high. For example, if the price of a grocery item you buy changes significantly each week, that's high volatility.
Risk Premium: The extra return expected by investors for taking on more risk. Imagine if you asked for $20 instead of $10 to mow a more dangerous lawn with lots of rocks; that's your risk premium.
Equity Index: A way to measure the value of a group of stocks. Think of it like an average score for a whole team rather than just a single player.
- Forced Sellers: These are investment funds that must sell stocks when prices get too volatile to stick to their rules, which can make the market look riskier.
In summary, UBS believes the recent fear in the market might be too much, and they see potential in certain 'quality' stocks and the utilities sector. They remain optimistic about future returns on selected investments.
