<p><img src="https://static3.businessinsider.com/image/60f05c4bd1026600182c5b9e-2400/GettyImages-1264127452.jpg" border="0" alt="Inflation and stock appreciation" data-mce-source="Malte Mueller/Getty Images" data-link="https://www.gettyimages.com/detail/illustration/businessman-inflating-dollar-sign-balloon-royalty-free-illustration/1264127452'adppopup=true"></p><p></p><bi-shortcode id="summary-shortcode" data-type="summary-shortcode" class="mceNonEditable" contenteditable="false">Summary List Placement</bi-shortcode><p>At the <a href="https://www.businessinsider.com/june-fomc-announcement-2014-6">June FOMC meeting</a>, Federal Reserve members revealed <a href="https://www.businessinsider.com/federal-reserve-interest-rate-projections-fomc-june-inflation-monetary-policy-2021-6">interest rate projections</a> that pointed to a rate hike in 2023, with some officials projecting hikes as early as next year.</p><p>A majority of FOMC members noted that inflation risks were now skewed to the upside, and the overall tone of the meeting was more hawkish than many market watchers had anticipated.</p><p>In the weeks since, 10- and 30-year Treasury yields have dropped, and the reflation trade in economically sensitive sectors like financials, energy, and materials has underperformed while tech stocks have rallied.</p><p>Normally when inflation concerns rise nominal bond yields follow a similar path, but that hasn't been the case this time.</p><p>This paradoxical market response can be explained by the market's view that the Fed is going to make a policy mistake by hiking interest rates too soon, thereby derailing the economic recovery.</p><p>That's according to UBS Global Wealth Management's chief investment officer Mark Haefele, who believes investors shouldn't fear Fed tightening or a policy mishap that kills the economic recovery. </p><p>The CIO sees Treasury yields rebounding through the second half of 2021, with the 10-year moving to 2% by year-end, in part due to easing downward technical factors in the bond market.</p><p>US consumers' <a href="https://www.businessinsider.com/americans-record-low-disposable-income-pay-debt-household-service-ratio-2021-7">strong financial position</a>, which was boosted by fiscal stimulus and suppressed spending levels during the pandemic, combined with businesses' need to use CAPEX to replace lost operations, will sustain economic momentum, Haefele says.</p><p>In a June 16 note to clients, Haefele, who leads investment research at the largest wealth management office in the world, said he prefers a risk-on stance for investors and is confident the economic recovery is still underway.</p><p>"We do not believe that the 'secular stagnation' narrative is supported by the underlying data at this time. We are staying positive on risky assets, expect yields to move higher by year-end, and continue to advocate positioning for reopening and recovery," Haefele wrote.</p><p>The CIO went on to detail five strategies that will help investors position their portfolios in this paradoxical market environment and profit from the comeback of the reflation trade.</p><h3>1) Position for reopening and recovery</h3><p>Haefele recommended investors add exposure to energy and financials through year-end. The CIO said energy stocks will benefit from rising oil prices in the second half of 2021 while financials will get a boost from 10-year Treasury yields move to 2%.</p><p>Haefele no longer prefers small-cap equities because they typically outperform in the early stages of economic rebounds but lag as the recovery matures. The CIO and UBS now recommend investors look to quality mid-cap names while reducing small-cap exposure.</p><h3>2) Seek opportunities in Asia</h3><p>Haefele sees opportunities in emerging markets in Asia due to recent underperformance, which has created attractive valuations against a strong earnings backdrop.</p><p>The CIO also believes Chinese equities can outperform in the second half of 2021 due to the People's Bank of China (PBoC) adopting a more "pro-growth" monetary policy. The bank cut the <a href="https://markets.businessinsider.com/news/stocks/the-pboc-cuts-its-rrr-by-50-basis-points-10317001">reserve requirement ratio (RRR)</a> for nearly all Chinese banks by 50bps earlier this month.</p><p>Haefele noted that Japanese equities could offer the most upside for investors in Asia, however. The island nation's stock market is exposed to global growth and geared toward cyclical sectors that the CIO believes will continue to outperform. Japanese stocks should also benefit from a weaker yen and high operating leverage, Haefele said.</p><p><img src="https://static2.businessinsider.com/image/60f58b45bc757c001904ba29-1030/Japan cyclical UBS.png" border="0" alt="Japan cyclical UBS" data-mce-source="UBS"></p><h3>3) Position for structural growth</h3><p>Haefele said investors should diversify away from overbought large-cap tech names and into small and mid-cap stocks that will benefit from structural growth. The CIO recommended names in the growing digital subscriptions space in particular.</p><p>Investors might consider an ETF like the <a href="https://markets.ft.com/data/etfs/tearsheet/summary's=DGTL:LSE:USD">iShares Digitalisation UCITS ETF</a>, which tracks an index of developed and emerging market companies generating revenue from digitalization, as a proxy for Haefele's recommendation.</p><h3>4) Protect against inflation</h3><p>Although Haefele believes inflation will likely be "transitory," as the Fed has described, the CIO said investors should add exposure to <a href="https://www.businessinsider.com/investing-strategy-best-stocks-to-buy-to-survive-inflation-ubs-2021-6">stocks with pricing power</a>, short duration bonds with a strong yield, and commodities such as oil to defend against the potential for longer-term inflation.</p><h3>5) Protect against downside risks</h3><p>Haefele recommended investors remain overweight risk assets but suggested a regular review of portfolios for excessive risk. The CIO said investors might consider locking in profits from stocks that have outperformed, adding downside protection in the form of hedge funds or derivatives, or even diversifying into <a href="https://markets.businessinsider.com/news/stocks/7-best-stocks-to-buy-to-hedge-against-a-potential-downturn-1030484539">defensive stocks</a> to protect against downside risk from a COVID-19 delta variant surge or more sustained inflation.</p><p><a href="https://www.businessinsider.com/5-stock-investing-strategies-profit-inflation-trades-fed-policy-ubs-2021-7#comments">Join the conversation about this story »</a></p> <p>NOW WATCH: <a href="https://www.businessinsider.com/ultimate-cross-country-us-road-trip-every-state-2015-5">The shortest route for a road trip across the US to see 50 national landmarks</a></p> Click here to read full news..