Banking

UBS names 3 industries to buy into — and 4 to avoid — as stock pickers face an ‘impossible trinity’ of tighter financial conditions, slowing earnings, and steady inflation

  • Stock pickers face an “impossible trinity” of macro conditions, UBS analysts said in a recent note.
  • A hawkish Federal Reserve, slowing earnings growth, and steady inflation may haunt stock pickers.
  • Here are three industries to target in this shifting landscape — and four to stay away from.
  • See more stories on Insider’s business page.

Investors should get choosy as tightening financial conditions, slowing earnings growth, and falling inflation form an “impossible trinity” for stocks, UBS strategists warned in a June 23 note.

US economic growth is peaking after a robust recovery from pandemic-induced lockdowns, as evidenced by high but falling measures of corporate earnings growth and inflation, wrote UBS strategists Keith Parker and Alastair Pinder.

Now, all eyes are on the

Federal Reserve
and whether it will keep its foot on the gas pedal or ease off the fiscal stimulus. Fed officials signaled in a mid-June meeting that the US central bank may lift interest rates twice in 2023, about a year earlier than expected, in response to strong inflation.

Pulling the plug too early on monetary stimulus by slowing bond purchases and hiking the federal funds rate would send volatility spiking, as evidenced by the “taper tantrum” in May 2013 when Fed officials announced a tapering of bond purchases that investors saw as premature. 10-year Treasury note yields soared 50% to 3% by the end of 2013 from about 2% in mid-May.

Even if the Fed keeps its easy policy in place, slowing economic growth may signal a pause in an outstanding run for economically sensitive cyclical sectors like energy, financials, industrials, and materials, which are up between 13% and 41% in 2021. Cyclicals’ gains can continue if growth declines gradually, but stock pickers should get more selective, UBS strategists wrote.

High but receding inflation as well as tightening financial conditions further complicate the backdrop for stocks going forward, the note read. While inflation can be a tailwind at low levels in economic recoveries, UBS strategists wrote that higher inflation levels — reflected by yields above 2.5% on the 10-year note — would adversely affect stocks.

In response, investors should get more tactical in their sector approach, targeting select cyclical stocks and gradually increasing growth and quality holdings, the strategists wrote.

UBS broke down the sectors and industries likely to outperform given the complicated backdrop of more stringent Fed policy, as well as high but dropping economic growth and inflation marks.

The three industries best suited to outperform in this new environment are Energy, Pharma & Biotech, and Telecoms. Among cyclical industries, Consumer Services, Technology Hardware, and Transportation rank well, and the Food, Beverage & Tobacco industry stands out from its defensive peers, according to UBS.

UBS didn’t name any specific stocks or ETFs it liked to top the market, but investors could look to add energy exposure with the Energy Select Sector SPDR Fund (XLE), up 39.9% year-to-date; build a biotech position with the iShares Biotechnology ETF (IBB), which has risen 7.1% this year; or ride the telecom trend with the ProShares Ultra Telecommunications (LTL), which has climbed 25% in 2021.

Conversely, the industries to avoid in light of tighter US monetary policy and slowing growth and inflation are Automobiles, Consumer Durables & Apparel, Household & Personal Products — and Materials ranks worst, given the industry’s economic sensitivity.

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