Equity rally should withstand higher yields – UBS

Government bond yields rose last week as central banks signal that policy may be tightened faster than previously anticipated. But while economists at UBS expect the rise in yields to go further, they do not see this becoming disruptive or halting the equity rally.

Modestly higher rates look likely to impact relative sector performance

“Even if the 10-year yield rises to 1.8% by the end of 2021, and to 2% in subsequent months, the equity risk premium – which indicates the relative appeal of stocks versus bonds – will still leave equities looking attractive, all else equal. 

“Rather than ending the equity rally, we expect the rise in yields to favor cyclical sectors such as financials and energy over growth sectors such as technology, which experience a bigger drag on the present value of future cash flows from higher rates.”

“While policy will tighten at a different pace around the world, we expect top central banks to remain broadly accommodative and only tighten as output gaps narrow and employment conditions improve. Against this backdrop, we expect cyclical parts of the market to outperform, including energy, financials, and Japanese stocks.”