Lucy Handley

A sign of Swiss banking giant UBS is seen at a branch in Zurich on October 26, 2018.
Fabrice Coffrini | AFP | Getty Images
Analysts at UBS have tackled investors’ “most difficult questions,” seeking to explain a range of subjects including Chinese regulation, inflation and which sectors are likely to continue reporting higher earnings.

In a Sept. 29 research note titled “The Compendium – The 10 toughest questions we’ve fielded,” analysts led by Arend Kapteyn concluded that lockdowns imposed by governments due to the Covid-19 outbreak now have less of an effect on GDP growth than when the pandemic started.

Answering the question: “Can mutant viruses derail the recovery?” they stated: “We find that a one point increase in mobility restrictions has crimped GDP growth far less in the past few quarters … than a similar increase in the first few quarters of the pandemic … when measures were less targeted, firms had not yet adapted to more online sales, and there were amplifying effects on supply chains.”

Can earnings go higher?
Stocks reached near all-time highs last month and answering the question: “How long will the earnings upcycle extend?” the analysts said some sectors could continue to report higher earnings until the start of next year. “Earnings momentum in Energy and Materials will likely fade just as fast as it rose. These sectors, along with Industrials, can also derate quickly. IT, Communication Services, Financials and Consumer Discretionary will likely help extend this earnings expansion until Q1 2022,” they stated.

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In terms of the reflation trade, where investors bet on economic growth, the bank expects global expansion to be around 8% for the rest of the year, before slowing to 5% in the first half of 2022. In answer to the question: “How much reflation room is left in this cycle?” the analysts noted that labor market data is “later cycle” than might be imagined. “The big surprise here is that Europe has now recouped more of the lost labour from this pandemic than the US.” The bank added it expects earnings to “surprise on the upside” over the next three to six months.

The China question

China’s new “common prosperity” drive aims to support moderate wealth for all and is set to see the country tighten regulation and credit. The government has already cracked down on tech companies, which has wiped billions from the sector in the last few months.
While UBS said regulation affects growth stocks in China — assets such as tech that investors expect to outperform the wider market — it also has an impact on value stocks globally, or those shares that are perceived to be trading with cheaper valuations.

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In answer to the question: “What does Common Prosperity in China mean for markets?” the analysts said: “We believe the new regulatory reality can be priced into Chinese stocks before long, but that the impact of weaker credit growth in China over the medium term is not fully priced in global assets.”

What about supply chains?
During the pandemic, a switch in consumer spending from service-led businesses — such as restaurants — to goods like home furnishings caused a “trade imbalance” that led to container shortages in Asia, where some of those products are manufactured, the analysts noted.
Semiconductor chips, used in everything from autos to smartphones, have been in short supply too. In answer to the question: “Are supply bottlenecks dissipating?” the analysts stated: “As vaccine roll-out is now allowing economies to reopen, expenditure should start to switch back to services and take pressure off of global trade.”
Inflation, liquidity and the fiscal cliff

When asked: “Is temporary inflation becoming permanent?” the analysts said they expect most of the current inflation to “dissipate.” “The surprise has been in items that were already experiencing strong inflation last year seeing even faster inflation this year,” the analysts stated, with sectors including food. “Only a small amount of the rise in inflation is likely to be permanent, and as supply and demand edge back toward the pre-pandemic composition … a moderation in inflation is likely,” they added.

In terms of liquidity in the market, where central banks have provided fiscal stimulus since the start of the pandemic, UBS noted that “all major central banks [are] expected to be tapering, or indeed ceasing, asset purchases by the turn of the year.” For example, the European Central Bank slowed its bond purchases in September, though it said this was a recalibration rather than tapering. Answering the question: “What is the outlook for liquidity, and what does it mean for markets?” the analysts concluded: ”‘Growth’ may drive the market for a while longer even as liquidity gets exhausted. But as earnings momentum also ebbs, likely in Q1 ’22, expect a clear downshifting of returns.”

When it comes to a fiscal cliff — referring to the potential end of government pandemic stimulus — UBS said it is “mainly a US story” and that the cliff “may well evaporate,” in answer to the question: “Can the fiscal cliff next year derail the recovery?” “Delayed stimulus spending’ by consumers (i.e. drawdowns of excess savings) could provide a meaningful offset to fiscal drag in 2022,” the bank added.

Fiscal deficits and monetary policy
The U.S. has had so-called twin deficits for some time, meaning that its current account and fiscal accounts are both spending more than they are taking in. The current account refers to overseas transactions — and the U.S. is currently spending more on imports than it is making on exports — while the fiscal account refers to domestic spending on big projects such as infrastructure. Answering the question: “Has the dollar troughed if twin deficits and the cycle have peaked?” the analysts stated: “There is a pattern of lags between twin deficits peaking and the dollar’s performance. We remain bearish the dollar against G10 currencies.”

Investors also asked UBS about whether the “neutral rate” has moved up or down, referring to the natural interest rate that occurs when inflation and the economy are stable. It is used by the Federal Reserve to make monetary policy decisions and UBS estimated that the neutral rate will reduce from 2.5% pre-pandemic to 1.7% by the end of 2023. The bank suggested that the Fed would therefore “keep rates relatively low” — it has held interest rates near zero.