Economic policy remains supportive for stocks
What did we learn this week?
The Fed is starting tapering…
The Fed announced a USD 15bn monthly reduction in bond purchases, which fall to zero by mid-2022. Although Chair Jerome Powell sounded slightly more hawkish in his press conference, and acknowledged inflation is likely to remain elevated for longer, he reiterated the Fed’s patient approach to raising rates.
Japan elected a new government…
Japan’s ruling Liberal Democratic Party maintained its lower house majority, winning 261 seats, 15 fewer than its pre-election total.
US Senate Democrats found common ground on drug pricing…
including a new system of “negotiated” price discounts for some older drugs in Medicare, a lower cap on annual out-of-pocket (OOP) drug expenditure for Medicare patients, and limits on annual price rises.
How do we interpret this?
The Fed’s patience is supportive for stocks…
Elevated inflation and tightening moves by some smaller central banks have prompted concerns of premature tightening that chokes off growth. But Fed officials maintained their stance that inflation is transitory, even if it will likely take longer to recede than previously expected. The Fed gave no indications that early rate rises were needed to address rising prices. The Fed also provided reassurance that tightening was not on autopilot and could be slowed if the economy weakened. Policymakers remain eager to avoid the potential for future tantrums in either the bond or equity markets: Fed chair Jerome Powell reiterated, “We wouldn’t want to surprise markets.” The Fed’s patience should allay fears of premature rate rises and help avoid a sharp increase in yields and tighter financial conditions that could hurt stocks.
… as is Japan’s imminent fresh fiscal stimulus…
Japan was the only major equity market to decline in October, amid worries ahead of the general election. But the vote removes much of the uncertainty overhanging Japanese stocks and should pave the way for a period of outperformance. We think investors can now look forward to additional fiscal stimulus—we expect new fiscal spending worth JPY 20–30tr, or about 4–5% of GDP, and PM Kishida also softened his tone on the potential for tax increases.
… and the Democrats’ moderate compromise is positive for the healthcare sector.
If passed, the proposals will have limited impact on drug pricing. Price negotiations would apply to only a few drugs whose regulatory exclusivity has already ended, many of which face either generic or biosimilar competition. In addition, price discounts would follow a set schedule, limiting their impact on aggregate US drug industry revenues. While lower prices for some drugs are now more likely, the compromise rules are better for the biopharma industry than previous House proposals. Agreement among Democrats on drug pricing removes one obstacle to passage of the Build Back Better bill.
What does this mean for investors?
Although the S&P 500 reached new record highs last week, we think supportive economic policy, alongside good growth and earnings should support further equity upside. We like energy, financials, and US mid-caps, as well as Eurozone and Japanese equities.
Fiscal stimulus should provide a catalyst for corporate earnings growth in Japan. We see further support from the reopening of the economy, the cyclical exposure of the Japanese market, and the weakening yen.
We also like global healthcare. Prior breakthroughs after periods of heightened regulatory concern have acted as a catalyst for biopharma industry outperformance, and passage of the Build Back Better bill could offer a similar outcome. We note the global pharma sector currently trades at a 17% discount on forward P/E to global equities (MSCI All Country World), compared to a 20-year average premium of 3%. We expect regulatory clarity and reduced political pressure to narrow this discount over time.
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