A record $6 trillion in money market funds could flow into the stock market as the Federal Reserve gears up for interest rate cuts.
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While investors focus on the recent rotation out of large-cap stocks and into shares of smaller companies, UBS says there's an even bigger rotation trade on the horizon that investors should pay attention to.
That would be the rotation from cash and bonds into stocks, according to a Monday note from the bank, and it could help fuel a 17% rally in the S&P 500 by the end of the year.
With more than $6 trillion sitting in money market funds, investors could be compelled to reinvest that money in the stock market if the Federal Reserve moves ahead with rate cuts later this year.
Money market funds have been yielding around 5% on an annualized basis, but that interest rate would quickly drop after the Fed cuts rates, which is expected to happen in September.
The cash-to-stocks trade is the more durable rotation investors should be watching, UBS said. The small-cap rally that has captured investors' attention in recent weeks could quickly fizzle out if economic growth slows or if the Fed doesn't cut interest rates as much as expected.
"There is a fine line between good macro data and ideal conditions necessary for the rotation trade to be sustained," UBS head of asset allocation Jason Draho said of the recent rally in small-cap stocks.
But a lot is working in favor of the potential rotation out of cash and bonds and into the stock market, according to the note, and the move could coincide with a 17% gain in the S&P 500 by the end of the year.
"We still recommend that investors position for lower rates, seek quality growth stocks, and seize the AI opportunity," Draho said.
With the potential for solid economic data via continued disinflation, solid economic growth, and increased productivity from AI technologies, "it's certainly a plausible scenario" that could fuel a "Roaring '20s" outcome, which we conjecture has become increasingly likely," Draho said.
And while such a scenario would help lift all stocks, it would be even better for a select corner of the market, according to the note.
"This scenario should be good for small-caps and cyclical in absolute terms, but even better for tech, growth, and momentum stocks, as was the case in the late 1990s," Draho said.
Draho reiterated his year-end S&P 500 price target of 5,900, but said his bull-case scenario of the index hitting 6,500 by the end of the year is still possible.
"Immaculate disinflationary growth skews the outcome towards the bull case of 6500. There will be a rotation trade in that scenario, but from cash and bonds into stocks," Draho said.
