Investing.com -- UBS analysts see growing risks of a stock market bubble as bond yields rise, assigning a 35% probability of one forming in the near future.
The bank wrote in a note Thursday: “We see a 35% chance of a bubble.” UBS emphasized that a bubble could emerge if specific conditions materialize, especially within highly valued sectors like technology.
The analysts highlight that, historically, “the P/E of the bubble areas (which can encompass up to ~40% of market cap) gets to at least 45x” when bond yields rise to 5.5%.
Currently, the price-to-earnings (P/E) ratio for the so-called "Magnificent 6" tech stocks is at 34x. UBS points to the “abnormally good position of corporate (especially tech) balance sheets” compared to government finances as a factor that could support high valuations despite rising yields.
The note also provides a detailed analysis of regional performance under rising TIPS (Treasury Inflation-Protected Securities) yields.
UBS explains that Japan has historically been the best-performing region in local currency terms, while emerging markets with high current account deficits, such as Brazil, tend to underperform in dollar terms.
UBS advises caution with non-financial cyclicals, which it says are “pricing in very high PMIs and trade on near-record P/E and P/S relative to defensives.”
Instead, UBS prefers defensive stocks with low financial leverage, highlighting companies like Microsoft (NASDAQ:MSFT), Abbott, SAP, Tesco (OTC:TSCDY) and BAE Systems (LON:BAES).
For investors concerned about potential populist policies or inflation, UBS recommends being “long of financials as a hedge on populism.” European banks and life insurance stocks, in particular, could benefit if inflation expectations rise.