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UBS: Time to Focus on Fixed Income over Equities
Economic Slowdown Expected
UBS believes that now is the time to shift focus to fixed income over equities. Despite a strong first half of the year for the stock market, UBS predicts that the economy will slow and enter a mild recession later this year or in early 2024. The firm's chief investment office stated that while better-than-expected corporate earnings have supported equity markets, there is limited potential for these trends to continue.
The Appeal of Quality Bonds
Instead, UBS sees a better risk-reward proposition from quality bonds. With the Federal Reserve pausing their rate hikes and rates peaking, the firm recommends a barbell approach to fixed income allocations. This involves combining high-quality, short-duration bonds for income with long-duration bonds to benefit from rate declines. UBS also highlights that some fixed income products are more attractive than others at the moment.
Mortgage-Backed Securities
One of the fixed income opportunities that UBS rates as "most preferred" is mortgage-backed securities. These securities offer cash flows tied to the principal and interest payments on a pool of mortgages. UBS notes that the current coupon yield of 5.5% is near the 98th percentile of the last 10 years. Additionally, the AAA-rated sector has a current coupon spread at investment-grade corporate BBB levels. UBS expects material tightening in this sector by the end of the year.
U.S. Investment Grade Credit
UBS also considers U.S. investment grade credit as an attractive fixed income option. Not only do these corporate bonds offer a decent yield, but they should also continue to perform well even in a mild recession. UBS recommends locking in coupon income for the long-term, while providing a buffer for any potential spread widening.
Preferred Securities
Preferred securities are another preferred choice by UBS. These securities possess characteristics of both stocks and bonds, and are primarily issued by banks and financial institutions. UBS recently upgraded preferred securities to "most preferred" status. While there may be some volatility and episodic drawdowns in the coming months, current valuations provide attractive entry points. The firm suggests a coupon barbell strategy with relatively high coupons, as well as fixed-to-floating rate coupons and laddered call dates.
Overall, UBS advises investors to focus on fixed income investments, particularly mortgage-backed securities, U.S. investment grade credit, and preferred securities, due to the anticipated economic slowdown and potential for attractive returns in these sectors.
Conclusion
With UBS recommending a shift towards fixed income investments, specifically mortgage-backed securities, U.S. investment grade credit, and preferred securities, new businesses should take note of the potential impact this shift could have on their operations.
As the economy slows and a mild recession looms, it becomes crucial for businesses to carefully manage their finances and investments. This is particularly relevant for new businesses that may be more vulnerable to economic downturns.
The appeal of quality bonds lies in their risk-reward proposition. By combining high-quality, short-duration bonds for income with long-duration bonds, businesses can benefit from rate declines and secure stable cash flows. Moreover, UBS encourages businesses to focus on specific fixed income products that offer attractive returns.
Mortgage-backed securities, for instance, provide an opportunity for businesses to invest in cash flows tied to mortgage payments. With strong current coupon yields and the potential for tightening in this sector, investing in these securities can result in favorable returns.
U.S. investment grade credit, in turn, offers businesses the chance to earn decent yields even during a mild recession. Locking in coupon income for the long-term provides a buffer against spread widening and ensures stability in uncertain times.
Preferred securities, with their hybrid characteristics, can also be an attractive option for new businesses. Despite potential volatility, their upgraded status and attractive valuations make them a viable investment choice. Employing a coupon barbell strategy, combining high coupons with fixed-to-floating rate coupons and laddered call dates, can optimize returns.
In conclusion, businesses should consider UBS's recommendation to focus on fixed income investments. By strategically allocating their resources towards mortgage-backed securities, U.S. investment grade credit, and preferred securities, businesses can navigate the anticipated economic slowdown while maximizing potential returns and protecting themselves from market volatility.
Article First Published at: https://www.cnbc.com/2023/07/03/this-is-where-to-find-hot-yields-in-july-according-to-ubs.html
