Investing — The sharp rise in Treasury yields is seen as a headwind for stocks, but UBS analysts believe continued Federal Reserve rate cuts and the promise of artificial intelligence could provide a cushion for stocks to continue their bullish run to make.
“Historically, stocks have performed well in years when the Fed has cut rates when the U.S. economy has not been in recession,” UBS analysts said in a recent note.
The bullish environment for stocks comes even as 10-year U.S. Treasury yields have risen 60 basis points since early October. Rising government bond yields are usually a cause for concern for equity investors, as attractive returns often provide an alternative to equities while reducing the present value of future cash flows.
But yields have barely budged and remain about 2% below their recent record highs as the reason why rates rise matters, the analysts said.
When rates rise due to concerns about high inflation prompting Fed rate hikes – as seen in 2022 – stocks typically face headwinds. But this latest jump in rates is different – and likely to decline.
“While markets anticipated slightly higher inflation in the wake of Donald Trump’s election victory, much of the rise in yields was driven by hopes for stronger economic growth,” she added.
The consequences for future cash flows as a result of a higher discount rate have now been somewhat offset by optimism about the commercialization of AI.
“Markets have revised expectations for cash flows, more than offsetting a slightly less favorable discount rate,” the analysts said, predicting further upside potential for the S&P 500.
“[W]We expect the S&P 500 to reach 6,600 by the end of 2025, about 12% higher than its level at the time of writing,” she added.
