The sell-off in stocks is not a 'growth scare' and fundamentals are strong despite the recent valuation shock, UBS says

• Global economic growth prospects look intact despite the drawdowns in stocks, said UBS.
• Factory activity and China's easing of monetary and fiscal policy bode well for growth.

Stocks worldwide are suffering from a valuation shock but prospects for global economic growth look solid, according to UBS, which said it would look to take on risk in the midst of the equity selloff.

"The price action has been resoundingly negative in 2022. The underlying backdrop is not," Evan Brown, head of multi-asset strategy, and Luke Kawa, director of investment solutions, wrote in a note published Friday.

"Measures of factory activity have surprised to the upside even amid the rapid spread of the Omicron variant," and there's "meaningful evidence" that China is easing monetary and fiscal policy to stabilize economic activity," they said.

"This is a valuation-centric sell-off, not a signal that investors are pricing in a prolonged slide in global growth. 10-year US inflation-adjusted yields have risen more than 50 basis points since the start of the year. A move that big, that fast typically causes discomfort for risk assets," said UBS.

The Nasdaq-100 index, home to mega-cap tech stocks, has fallen into a correction, or a drop of 10% or more from a recent high, and the S&P 500 this week briefly touched correction territory. The Russell 2000 index of small-cap shares fell into a bear market, or a 20% fall from a recent peak.

Treasury yields have spiked up as investors sell off bonds in anticipation that the Federal Reserve will raise interest rates at least four times this year to cool down inflation that's soared to near 40-year highs. US consumer price inflation in December climbed to 7%.

While it's still early in the quarterly earnings season, financial results from Corporate America have been solid, the Swiss bank said. Earnings and sales surprises, growth rates and guidance are each running stronger than their long-term averages. "As expected, these are not as hot as they have been over the past year," it said, adding that global revisions to 2022 calendar year earnings haven't come under pressure.

"It is important to emphasize that the primary risk to stocks at the headline level remains multiple compression, not earnings growth turning to contraction," it said. Multiple compression takes place when earnings for a company have risen but the price of its shares hasn't increased.

European, UK, and Japanese stocks have declined this year but haven't lost as much as US equities. "We have preferred ex-US developed market equities in part because they are less expensive than US stocks and less susceptible to multiple compression," said UBS.

Germany's DAX benchmark has lost nearly 4% in 2022, Japan's Nikkei 225 has declined more than 7% and the UK's FTSE 250 mid-cap index was down about 9%. The UK's FTSE 100 index of large-cap shares was clinging to a gain of less than 1%.

UBS said the performance of credit and emerging market equities during January implies that investors' faith in the growth outlook "has not been materially shaken." It is, however, "cognizant that a further 10% decline in global equities would, by itself, be sufficient to raise alarm about the durability of the expansion."

The bank said the turmoil in stocks so far in 2022 hasn't spurred it to cut down on risk or change its preferred investment styles. "On the contrary, we have judiciously looked to add risk in some portfolios during this equity downdraft," UBS said.