Tuesday, January 19, 2010

What do rate hikes mean for equities?

What do rate hikes mean for equities?

Our forecasts

UBS economists are forecasting central banks around the world to start raising
interest rates in 2010. This is drawing increased questioning about the implications
for equity markets. We bring together our strategists in a collaborative effort to
look at equity performance around rate hikes and highlight regional differences.

Rate hikes and equity performance historically
We looked at 8 examples of rate increases in the US and found that on average,
equities historically posted solid, positive returns in the period leading up to the
first Fed tightening, with an average gain of about 16%. However, markets
typically registered just modest gains in the year following the first rate increase.

Regional comparison
Across the regions, the pattern of more moderate and choppy performance around
rate hikes is a uniform expectation. The biggest risk cited by our strategists is a
spike in ten year bond yields, underscoring that bond markets play a key role in
expectations for equity market performance. Currency appreciation is another risk,
in the case that central banks outside the US move aggressively before the Fed.

Elevated uncertainty
Policy tightening is likely to keep market uncertainty high. We recommend
investors ‘trade up’ in quality as the junk rally gives way. In global strategy, we
prefer a more balanced sector portfolio, but this differs around the globe. Our
strategists in Europe and Asia also recently made this move, whereas our US and
Canadian teams prefer to stay more cyclically positioned for now.


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