By Sam Boughedda
In a research note Wednesday, a UBS analyst told investors they are upgrading the consumer discretionary and consumer staples sectors and downgrading financials as they "get incrementally more defensive."
The analyst explained that after peak inflation, growth resilience is to matter more.
"With "peak" inflation/Fed hawkishness likely to underpin H2, economic growth and relative earnings momentum should matter more for returns based on our machine learning (ML) model analysis of baseline/recession macro scenarios. However, equities are already pricing a ~40% probability of recession the next 6mo and returns have been bifurcated based on whether one materializes or not," wrote the analyst. "Looking for better risk/reward, we get incrementally more defensive (u/g Cons Staples to o/w), selective on cyclicals (d/g Fins to u/w, u/g Cons Disc to o/w) and tilt toward quality growth (stay o/w Tech and Health Care)."
The analyst upgraded consumer discretionary to Overweight, stating that "with the <10x median fwd P/E for S&P Cons Disc near historical lows, pessimism is likely overdone given (1) robust spending, (2) balance sheet health, (3) Cons Svcs & Retail usually outperform late cycle, (4) peak inflation beneficiary."
He also upgraded consumer staples to Overweight, stating, "ML implied returns are better than Utilities/REITs, and Staples is cheaper. Strong pricing power and the Ag/commodity price fall is a tailwind."
However, on financials, the analyst downgraded the sector to Underweight as the risk/reward is unattractive around its baseline/recession scenarios, and "eventual peak Fed hawkishness would be a headwind."
"Rising credit losses, slowing capital market activity and muted buybacks are downside risks," stated the analyst.