Investing in stocks: A strategy to use from UBS amid rare conditions

The stock market landscape is dealing with conflicting signals around risk appetite as investors try to figure out what to do next.

UBS outlines what it thinks is the best possible strategy to take advantage of such an environment.

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During simple times, investing in the stock market can be divided into two simple categories: risk-on and risk-off.

When risk appetite is roaring, shares of tech and consumer discretionary companies look mighty appealing. When traders are fearful, they tend to pile into more defensive utility and consumer staple shares.

But what's an investor to do in a more complex market landscape that doesn't fit nicely into either category？ We're about to find out.

That's because we've entered a rare period characterized by mixed signals, according to UBS. On one hand, a disappointing spate of recent economic data suggests traders should be risk-averse. But the firm also expects Asia to recover more quickly than the US, giving a leg up to companies with foreign exposure.

“In essence, we expect investors to seek out companies with risk-off attributes, but specifically those that generate revenues abroad, and in Asia more particularly,” Francois Trahan, the head of US equity strategy at UBS, wrote in a client note. “This unusual mix of factors makes us think that stock selection might just matter more than sector selection in 2019.”

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The conclusion here is striking: Stock picking — an investing strategy derided and all but declared dead amid the rise of passive investing — is once again a viable strategy. This plays right into the hands of active managers who perform fundamental analysis on companies, then choose them accordingly.

But what about the torrid rally enjoyed by US stocks during the first quarter of 2019？ Couldn't that be fairly characterized by risk-on sentiment？ And wouldn't that derail UBS's argument？

Not if you zoom out and look at the bigger picture, says Trahan. If you look at the period from mid-2018 through present day, more defensively positioned counter-cyclical sectors have dominated. He's referring to utilities, consumer staples, REITs, and healthcare.

That overriding risk-off slant, combined with UBS's house view that an economic recovery in Asia will happen before the US gets one, leads to a compelling argument that stock picking will thrive — at least for traders skilled enough to identify the right companies.

“Indeed, the cross-currents we see for data in 2019 will likely throw a wrench in the typical playbook this year and leave us with some uncommon leadership trends,” Trahan said. “This could wreak havoc ... by fueling a mix of risk-on and risk-off attributes simultaneously.”