While investors focus on the recent rotation from large-cap stocks to small-cap stocks, UBS points out that there is a larger rotation trade that may be coming that deserves investors' attention.

The rotation from cash and bonds into stocks has the potential to drive the S&P 500 up 17% by the end of the year, according to a report released Monday by the bank.

With more than $6 trillion currently sitting in money market funds, investors are likely to reinvest that money in stocks if the Fed moves forward with rate cuts later this year. Money market funds earn an annualized rate of about 5%, but that rate will fall quickly after the Fed cuts rates, which are expected to happen in September.

UBS said the cash-to-equity rotation is a more persistent rotation that deserves investors' attention. The recent rally in small-cap stocks has attracted investors' attention, but this rotation could fade quickly if economic growth slows or the Federal Reserve does not cut interest rates as much as expected.

“There’s a fine line between macro data and ideal conditions for rotational trading to continue,” Jason Draho, head of asset allocation at UBS, said of the recent rally in small-cap stocks.

According to the report, there are a number of factors that favor a rotation out of cash and bonds and into stocks.

“We still recommend investors prepare for lower interest rates, seek out quality growth stocks, and seize opportunities in artificial intelligence,” Draho said.

“With continued disinflation, solid economic growth and productivity gains from AI technologies, the data could be strong, which is certainly a plausible scenario and could lead to a ‘roaring 20s’ outcome, which we speculate is increasingly likely,” Draho said.

While this scenario would help boost all stocks, it would be better for one particular sector of the market, the report said. “While this scenario is definitely good for small-cap and cyclical stocks, it’s even better for tech, growth stocks, as was the case in the late 1990s,” Draho said.

Draho reiterated his year-end target price of 5,900 for the S&P 500, but said a bull case scenario of the S&P 500 reaching 6,500 by the end of the year is still possible. "Perfect disinflation tilts the outcome toward a bull case of 6,500," he said. "In that case, there would be a rotation trade from cash and bonds to stocks."

Article forwarded from: Jinshi Data