What should investors do as the Fed cuts rates? UBS weighs in.

Investing.com - Markets are facing an "unusual" economic situation as the Federal Reserve embarks on a potential series of interest rate reductions, according to analysts at UBS.

In a note to clients, the analysts led by Andrew Garthwaite flagged that 56% of the time when the Fed has slashed rates, there has been a recession, on average, five months following the drawdown. Historically, there has also been a recession every time after the Fed has brought down rates by more than 75 basis points over the last four decades.

"However, we don’t see the classic preconditions for a recession (commodity shocks, excess private sector or bank leverage or clear-cut excess investment)," the UBS analysts wrote.

"The only time the Fed restarted an easing cycle without being accompanied by a recession was June 2002, so this situation is unusual."

On Wednesday, the Fed cut rates as expected, bringing down borrowing costs by a quarter point to a target range of 4% to 4.25%, and indicated that two more reductions may be coming in October and December.

Against this backdrop, the UBS analysts said tech stocks, which have already been bolstered by a surge in enthusiasm around the potential applications of artificial intelligence, have outperformed 75% of the time in the 12 months after the first rate cut. Software names, in particular, have notched gains if short rates fall more than long-dated ones and no recession transpires, they added.

Their preferred stocks in the tech space include Facebook-owner Meta Platforms (NASDAQ:META), software giant Microsoft (NASDAQ:MSFT), and e-commerce titan Amazon.com (NASDAQ:AMZN), as well as power management group Eaton (NYSE:ETN) and France’s Schneider Electric (EPA:SCHN).

They are also overweight gold stocks, as the yellow metal has "actually risen on all occassions in the 1, 3, 6, and 12 months after the Fed restarts a cutting cycle."

However, the risk of a financial market bubble "could be in generative AI, electrification and gold," the analysts warned.

Elsewhere, the strategists recommended that investors "focus on emerging markets" and stocks indirectly exposed to these regions such as Coca-Cola (NYSE:KO), Prosus (AS:PRX), Reckitt Benckiser (LON:RKT) and Ashmore (LON:ASHM). They are also overweight European banks, arguing that the European Central Bank -- unlike the Fed -- is not cutting rates and could even lift borrowing costs by the end of 2026.