Markets are rapidly discounting a late-cycle earnings phase, leading to UBS reposition its weighting on equity sectors.
“According to our model, the probability of earnings being ‘late cycle’ jumped 35pp in 2+ months (as implied by valuations), compared to taking 15+ mo in 2018-19 to move 35pp,” strategist Keith Parker wrote in a note Tuesday. “The shift in Fed expectations YTD was a 3stdev move with the 10-2y curve flattening 2+ stdev.”
“Based on our machine learning model, Russia / Ukraine risk has dominated relative returns since end Feb with some risk still priced. But growth developments are becoming a more important driver after real yields and inflation expectations already reset.”
Parker is Boosting Tech (NYSEARCA: XLK) to Overweight.
“Software (XSW) has underperformed the S&P 500 index by 10% in the last 6 months,” he said. “We believe Software can outperform the index supported by strong forward earnings and sales growth relative to the S&P 500.”
“Tech 12m forward earnings and sales growth have recovered from recent lows and are both now above S&P 500 growth. As the market worries more about recession risks, an improving relative growth profile for Tech should support Tech outperformance – as is typical at this stage of the cycle. “
“Rates risk remains an overhang for the Tech sector, but relative underperformance YTD was notably more than our ML model would have predicted. Assuming rates consolidate in line with UBS rates strategy’s view, relative growth for Tech should matter more after the YTD de-rating . “
He also upgrades Real Estate (NYSEARCA: XLRE) to Overweight.
“Real Estate forward sales growth has improved since early 2021 but performance is yet to follow,” Parker said. “We see better relative growth expectations amid inflation as supporting REITs, particularly since most of the market cap for the sector is in higher growth segments (ie towers, industrial, storage, etc.) compared to at risk retail and office.”
And he downgraded Industrials (NYSEARCA: XLI) to Underweight.
“Industrials have also fallen considerably in our scorecard to u / w with risks to the manufacturing cycle,” Parker said. “Tech has outperformed the Industrials sector when the ISM manufacturing index has declined.”
Long tech dropped to third in the list of most crowded trades in BofA’s April fund manager survey.