UBS Equities-US Equity Strategy _What 5 UST yields might mean for US equ...

ab3 June 2025Global ResearchUS Equity StrategyWhat 5% UST yields might mean for US equitiesThe UST yield is not an islandThe 10-year US yield represents a good proxy for the global risk-free rate and is widely used in discounted cash flow modelling for this purpose. While analysts will adjust estimates for the equilibrium 10-year yield infrequently, the market is adjusting it constantly. However, yield changes (themselves driven by real and inflation components) are almost always coincident with changes in the other components of equity returns, including risk premia and cash flow forecasts. Our Market Cookbook is specifically designed to disentangle the variable effects of discount rate changes across equity markets. We have used it to see what 5% UST yields could mean for US equities. Our Global Strategy colleagues wrote on this rising risk in January, and noted in their recent feedback from Asia that it is an underappreciated risk amongst investors currently.Term premia risks – a special caseThe sharp rise in term premia in recent years is a special case of UST yields moving without much effect or correlation with other components of the discount rate. Uncertainty, deficits, debt burdens, and potential disincentives for US inbound portfolio flows (Section 899 of the budget) are worrying investors and raising term premia in waves. This is possibly the easiest but worst way (for equities) for the UST to reach a 5% yield. Generally, if only real yields or inflation expectations are rising with no changes in risk premia or cashflows, it is negative for equities and especially those with longer 'duration' of cash flows (either defensives or growth companies). We haven't modelled this specifically, and show historic betas to yields/inflation are worst (on rising yields) for Utilities followed by Consumer Staples and Health Care stocks.Growth surprises may be more relevant in the short termWe have taken a potentially more optimistic view in our scenario analysis in this note. In our scenario, we assume the recent resilience in hard data in the US continues, tariff revenue supports fiscal stimulus, and the proposals in the budget that incentivize investment in non-residential construction and manufacturing capacity are successful. We think this could lift both real yields and inflation expectations, but also support profit growth expectations (lower risk premia). Our Market Cookbook looks at how our reasonable forecasts for changes in these variables have historically impacted the market, sectors, and industry groups, and also whether there are useful option strategies to position for what would be a highly unexpected outcome for the US economy and markets.Positioning for upside risks from rising yieldsWe see the S&P 500 trading up to 6200 on moderate (mid-teen) realized volatility. Our models show potential for outperformance from Airlines, Mining, and Consumer Discretionary stocks, while defensives like Consumer Staples and Health Care stagnate. Go