UBS says the 2 biggest stock market fears are completely overblown …

animated traderReuters
/ Brendan McDermid

  • Even though the stock market keeps hitting record
    highs, investors continue to find new reasons to be
  • UBS tries to dispel these concerns, calling for the
    SP 500 to climb as much as 9% from current levels by the
    end of 2018.

Investors seem awfully scared, considering the stock market has been
routinely hitting record highs.

Some fear that the factors that have catalyzed one of the
strongest US bull markets are bound to overheat. Others think
that the ongoing rally is too good to be true and that any
disruption to current conditions could send stocks tumbling.

UBS doesn’t agree. It sees the SP 500 climbing by as
much a 9% through 2018, hitting any number of new highs along the
way. And it wants to dispel two of the biggest concerns it hears
voiced by investors.

Stocks are overvalued, and global equities are in a bubble

This is a popular argument, and its disciples cite measures such
as the price-to-earnings ratio for various indexes and the
so-called Shiller CAPE ratio — both
of which are historically stretched. Some have even gone as far
as to call it a bubble.

UBS rationalizes the levels seen in these measures, arguing that
the slow global growth environment causes gradually growing
corporate earnings to be discounted at low risk-free yields. And
you get higher average valuation multiples as a result.

“Adjusting P/Es for the decline in risk-free yields, we find that
despite ongoing multiple expansion, on an interest rate adjusted
basis, valuations are within the post-crisis ranges in the US and
slightly higher than those in Europe and Japan,” UBS said.

Central-bank tightening will suck the life out of stocks

UBS acknowledges that yields will feel some upward pressure as
central banks remove accommodation — but it doesn’t see it
happening to an extreme degree. To its analysts, the stock market
will be fine as long as tightening measures are done with a soft

Assuming economic growth continues to churn gradually higher, and
inflation doesn’t spike suddenly, central banks should have
plenty of room to hike interest rates gradually and on a
predetermined schedule. UBS even foresees a situation in which
stocks continue rising in tandem with yields.

Overall, while 9% is the firm’s most optimistic forecast, it
actually has six models for the SP 500 in 2018. As shown in
the chart below, equity appreciation has four key components: CPI
inflation, income (dividends, buybacks, reinvestment), real
equity risk premium, and the real risk-free rate.

Regardless of which mix you think is most accurate, UBS’ stance
is undeniable: stocks are going to continue higher, and the
market’s fears are overblown.

Screen Shot 2017 11 09 at 4.39.01 PMUBS

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