UBS says get ready for global equity rotation

Bloomberg

Less easy financial conditions will likely lead to lower overall returns in global markets while favouring growth stocks over value, according to UBS Group AG.
Growth and earnings will become bigger drivers of returns next quarter, strategists including Bhanu Baweja wrote in a note. A bottoming in real rates and credit spreads will signal the end of a liquidity “tailwind,” they said.
“While these changes don’t imply a big drawdown, they do make for an important change in the nature of the rally,” the strategists wrote. “Liquidity tailwinds have been the biggest contributor to market gains.”
A recent surge in US real yields has raised alarm among investors who see negative real rates as a cornerstone of the risk-asset rally which has sent global equities to all-time highs. While higher real yields signal the economy is gaining traction, they can lead to a tightening in financial conditions and a shift in asset allocation.
The rate on 10-year Treasury Inflation-Protected Securities jumped to as high as minus 0.77% last week from minus 1.08% on February 11.
“A small increase in real rates will likely not be a big concern, but as real rates accelerate, each incremental move becomes more challenging for markets,” wrote Baweja and his team.
The “phase change” from a liquidity-driven market to one based on growth and earnings will come as “inflation enthusiasm” peaks and will precede any tapering of Federal Reserve support, according to the UBS team.
An analysis of similar episodes when liquidity drivers shift to neutral from loose suggests lower market returns and growth stocks marginally outperforming value shares, UBS said.
The dollar usually sees modest gains against emerging-market currencies and a rotation out of the US into other markets becomes less compelling, the strategists wrote.