In a note to clients Tuesday, UBS analysts highlighted the potential for a significant rotation trade that could propel the to 6500. They state that this shift from cash and bonds into stocks hinges on maintaining an ideal macroeconomic environment.
The equity markets experienced a dramatic shift in July. The investment bank notes that previous leaders like the , which rose 16.7% in the first half of 2024, fell by 0.6% in July. Conversely, laggards such as the surged by 7.6% after a modest 0.9% rise in 1H24. Regional banks and non-profitable tech stocks also saw significant gains.
UBS attributes the rotation trade’s potential to “steady growth at or above 2%, falling inflation, and preemptive Fed insurance rate cuts.”
They state that recent data has been encouraging, with inflation below expectations and disinflation trends continuing due to declining shelter inflation.
Furthermore, they note that the Atlanta Fed GDPNow tracking estimate for Q2 growth rose to 2.7%, easing concerns about slowing growth. Moreover, Fed officials have implicitly supported a September rate cut by not opposing market pricing for one.
However, UBS warns that investors might be overly optimistic about the extent of Fed rate cuts. The market currently prices in 65bps of cuts this year, including a likely September cut, and over 100bps in 2025. UBS says this is aggressive if growth remains around 2% and inflation above 2%. They emphasize that only an ideal macro environment can sustain the rotation trade.
Investor positioning has significantly amplified the rotation trade, with increased call option activity on small-caps and surges in retail fund flows into small-cap ETFs. However, UBS expects these technical influences to dissipate soon, leaving the continuation of the rotation trade dependent on sustained ideal macro conditions.
Despite the market rotation, UBS maintains its core investment strategy: positioning for lower rates, focusing on quality growth stocks, and leveraging AI opportunities. They project a year-end S&P 500 target of 5900, with a bull case of 6500, driven by “immaculate disinflationary growth” and sustained high productivity growth, particularly from AI advancements.
