UBS told investors on Tuesday not to overreact to the Federal Reserve’s expected interest rate increase this week.
The bank argued that history shows the stock market has often remained resilient after the Fed begins a new tightening cycle.
UBS Keeps Bullish S&P 500 Targets
UBS expects the Federal Reserve to raise interest rates on Wednesday.
However, the bank believes corporate earnings growth will remain a more important driver for stocks than the first rate hike itself.
UBS maintained its S&P 500 target of 8,100 for the end of the year and 8,400 by mid-2027.
History Shows Stocks Often Rise After the First Fed Hike
UBS reviewed 16 Federal Reserve rate-hike cycles dating back to 1954.
According to the bank, the S&P 500 gained an average of 10.8% during the 12 months following the first rate increase.
UBS strategists also noted that the market has not entered a bear market within the first year after the beginning of any of those tightening cycles.
That history suggests the first Fed rate hike does not automatically signal trouble for stocks.
Economic Growth Matters More Than Rate Hikes
UBS believes the strength of the economy is more important for equity performance than interest rate increases alone.
The bank highlighted the new orders component of the ISM Manufacturing Index as one of the strongest indicators of stock market performance following the start of a hiking cycle.
Manufacturing activity remains in expansion territory, which supports the case for continued economic growth.
AI Investment Could Support Further Expansion
Strong spending on artificial intelligence infrastructure could also help support the economy and corporate earnings.
UBS expects AI-related investment to continue expanding through at least 2027.
As a result, the bank believes the current economic environment looks more consistent with continued expansion than with a major contraction.
Stock Valuations Have Already Declined
UBS also argued that part of the negative impact from higher interest rates may already be reflected in stock valuations.
The S&P 500’s forward price-to-earnings ratio has fallen to around 19.5, compared with roughly 22 at the beginning of the year.
The decline came as the benchmark 10-year US Treasury yield moved toward 5%.
Lower valuations could provide some protection if interest rates rise further.
UBS Does Not Expect Aggressive Fed Tightening
The bank does not expect the Federal Reserve to launch the type of aggressive tightening campaign seen during some previous inflation-fighting periods.
UBS believes part of the recent inflation pressure comes from temporary factors.
If inflation begins to ease, the Fed may have less reason to push rates significantly higher.
AI Infrastructure Remains a Key Risk
UBS identified AI infrastructure investment as one of the biggest medium-term risks for the market.
Higher financing costs could eventually slow spending on large technology projects.
However, the bank believes interest rates would need to rise much further before borrowing costs become a serious constraint.
For now, UBS remains constructive on stocks and believes economic growth and earnings could continue to support the S&P 500 even as the Federal Reserve begins raising rates.
