UBS: Buy stocks on dips, gold and other commodities pullback as Fed rate hike expectations rise.

Author: Xiao Yanyan, Jinshi Data

The unexpectedly strong US non-farm payroll data for August is significantly changing market expectations for the Federal Reserve's September policy. UBS believes that the market volatility caused by the repricing of interest rate expectations may actually provide investors with opportunities to adjust their asset allocation.

Non-farm payrolls increased by 162,000 in August, far exceeding market expectations of 55,000, while the unemployment rate remained at 4.1%. This is the strongest monthly job growth since March.

After the jobs report was released, traders estimated that there was about a 60% probability that the Federal Open Market Committee (FOMC) would raise interest rates by 25 basis points at its meeting on September 15-16.

UBS stated that the key is not just whether the Fed will raise rates at its next meeting, but the economic reasons behind such a rate hike.

A team of strategists led by Mark Haefele, Chief Investment Officer of UBS Global Wealth Management, points out that there is a fundamental difference in the impact on portfolios between the Federal Reserve raising interest rates due to a strong economy and raising rates due to inflationary pressures. "There is a fundamental difference between the Fed acting in response to a strong U.S. economy and the Fed acting in response to inflation. This difference is far more important to portfolios than the next policy meeting," he said. UBS believes that the positive labor force data in August is closer to the former scenario, where the economy remains resilient and inflationary pressures are not the sole driver. If the market fluctuates due to expectations of interest rate hikes, UBS suggests that investors focus on several directions. Strategists say this includes buying stocks on dips while the earnings outlook remains strong, taking advantage of high yields on medium- to long-term quality bonds, reducing excess dollar positions when the dollar strengthens, and building long-term portfolio hedges after a pullback in gold prices. Equities: Volatility Offers Investment Opportunities UBS remains bullish on global equities. Strategists acknowledge that rising yields could cause short-term market volatility and put pressure on interest rate-sensitive sectors. However, even further monetary tightening may not outweigh several key factors driving the stock market in the medium term. These factors include AI-related capital expenditures, resilient economic activity, and broader earnings growth. "We remain bullish on the upside for equities and continue to favor AI, power and resources, and longevity-related themes, all of which should benefit from stronger investment, productivity gains, and structural growth," UBS stated. Bonds: Short- to Medium-Term Yields Not Worth Locking In UBS's assessment of government bonds is more divided compared to equities. If the market reprices policy rates further upward, government bond returns could be dragged down, and capital appreciation potential would be limited, especially at the short end of the yield curve. "We no longer recommend investors lock in short- to medium-term bond yields as a cash alternative," UBS strategists wrote. UBS is more focused on opportunities arising from the recent rise in medium- to long-term bond yields. These yields could provide both income and diversification for portfolios. If the Federal Reserve tightens policy, boosting market confidence in its inflation commitment and consequently lowering long-term inflation expectations or slowing GDP growth, medium- to long-term bonds could ultimately benefit. US Dollar: Strong Growth May Extend the Strong Cycle Regarding the US dollar, UBS believes that the Fed's hawkish shift is beneficial to the dollar, especially given the widening policy divergence between the US and other major central banks. "Tightening policies against a backdrop of strong growth could support the dollar for a longer period through stronger capital inflows and relative economic performance," UBS stated. However, if tightening is primarily driven by inflation while economic growth weakens, the dollar's outlook will be more complex. UBS points out that in this scenario, higher yields could counteract market concerns about fiscal sustainability and the long-term economic outlook. Gold: Short-Term Pressure, Still a Long-Term Hedging Tool The short-term environment for gold is not favorable. Rising real interest rates and a stronger dollar will both put pressure on gold prices. However, persistent inflation, geopolitical uncertainty, and market concerns about fiscal and monetary credibility could offset these headwinds and strengthen gold's role as a safe-haven asset. Therefore, UBS does not recommend treating gold simply as a tactical bet on the next Fed decision. "We currently view gold more as a portfolio hedging and diversification tool than a tactical expression of the Fed's next decision," said a UBS strategist. UBS also points out that commodities can provide both structural returns and asset diversification value in the event of energy supply shocks or renewed inflation becoming a problem for stock and bond markets. Electrification, increased electricity demand, investment in artificial intelligence infrastructure, and supply constraints collectively support the long-term prospects of this asset class.