UBS identifies a trigger that could spark a stock market sell-off in the second half

Published Thu, Jun 29 20237:50 PM EDTUpdated Fri, Jun 30 20234:24 AM EDT

Equities could sell off in the coming weeks due to several factors, including weak global growth and poor company earnings, according to UBS strategists. They said that many market analysts — including their own — predicted that a recession and weaker earnings would put stocks at risk in 2023, and the catalyst for a potential downturn may now be in sight. "Growth is weaker than in the investor narrative and much weaker than priced in markets," said UBS strategists led by chief strategist Bhanu Baweja in a note to clients on June 28. According to the bank, global growth is currently below 2% on an annual basis, significantly less than the long-term average of 3.5%. "But we likely don't have to wait for the onset of big earnings downgrades to see lower equities. A starting point of low stock correlations, credit rating downgrades, and an acceleration of liquidity drain suggest valuations will likely get compromised before earnings do," they added. UBS expects the S & P 500 to close at 3900 by the end of the year, or down around 10% from current levels. .SPX YTD line Deterioration of credit? One particular issue UBS strategists noted was the health of the credit market. The weakest segment of credit, leveraged loans, is vulnerable to higher floating rates and a rise in defaults, they said. Matthew Mish, head of credit strategy at the bank, noted that UBS' latest research had noticed an uptick in factors that could worsen credit conditions. "We're watching credit ratings migration, and May to date seems to be the worst month that we've seen in at least 18 months in terms of downgrades to CCC as well as D or defaults," Mish told the bank's clients in a presentation earlier this month. When asked about indicators to watch ahead of an increase in credit spreads, Mish pointed to a rise in bankruptcy filings, worsening credit ratings, and falling traded prices for defaulted leveraged loans. He also identified technology, consumer and business services, and the health-care sector as being particularly at risk due to the high concentration and build-up of debt and lax underwriting standards over the past years. Addressing the argument that many firms may have deferred their debt issuance, thereby preventing a widening of credit spreads, Mish contended that this was "last year's argument." This year's reality, he said, is that while there may not be an imminent refinancing risk, weak earnings, and liquidity profiles could lead to companies being downgraded to the lowest ratings for debt (CCC or junk), which could result in substantially higher funding costs for those companies. All these factors point to a potentially challenging time ahead for equities. While UBS's consensus on the second-half earnings is lower than the market's expectations, the bank believes it may take until the third-quarter earnings for market estimates to be revised downwards.