House Call: Talking Equity Markets with UBS Asset Management
The desk interprets the recent volatility in equity markets as a significant yet typical correction phase, emphasizing the importance of historical context in understanding the current dynamics. Per the full note source, Jeremy Zirin from UBS Asset Management highlights that the S&P 500's recent 10% drop occurred over just 22 days, which is notably faster than the historical average of 75 days. This rapid decline reflects heightened market sensitivity, suggesting traders should brace for more instability in equities, which may spill over into forex markets as investor sentiment shifts. The next major focal point for the market is potential resilience indicators from equities that could trigger a tactical recalibration for USD pairs.
What the desk is arguing
The desk posits that the accelerated pace of the current correction in the equity markets warrants careful navigation from traders, especially within the FX sphere. According to UBS Asset Management, historical trends show that rapid corrections often result in heightened volatility that can reverberate across asset classes.
Zirin notes that in the last 60 years, while 40 corrections have been documented, this one stands out for its swiftness, reaching the 10% threshold in just 22 days. Such sell-offs typically signal a shift in investor confidence, which can impact currency valuations as traders recalibrate their positions in light of changing risk appetites.
Where it sits in our coverage
While we do not have internal coverage data on direct currency pairs related to equities at this moment, it is critical for traders to analyze developments in correlations between equities and key FX markets like EUR/USD and USD/JPY, which may mirror shifts in investor sentiment.
How other firms see it
Firms with a bullish perspective on equities, such as jpmorgan, likely support the view that the correction phase is a buying opportunity, while counterpoints from firms like bofa suggest caution due to the economic uncertainties that remain.
Related currency pairs like CAD/JPY and AUD/USD are also worth monitoring as indicators of risk appetite, reflecting how equity market fluctuations can manifest in currency movements.
01Recent S&P 500 correction was notably rapid, occurring in just 22 days.
02Historical context shows average corrections take around 75 days, highlighting current volatility.
03Investor sentiment is shifting, impacting FX positioning and strategy.
Market implications
Watch for dollar strength reflecting investor risk aversion during periods of equity sell-offs. Should the S&P 500 show signs of recovery, it may provide a counter-catalyst for USD weakness as investors shift back to equities.
Risks to this view
A reversal in this outlook could be prompted by significant economic data releases or shifts in central bank policies that restore investor confidence, particularly if equities rebound unexpectedly.
ubs
We are back now to continue with our ongoing podcast series with colleagues from UBS Asset Management. Back today with Housecall Perspective on Navigating Equity Market Volatility with UBS Asset Management. For today's conversation, glad to be joined again by Jeremy Zierin, Senior Portfolio Manager of the Houseview Equity Portfolios and Head of the Private Client U.S.
Equity Team. We're also joined today by Dominique Shager, Senior Equity Investment Specialist with UBS Asset Management. So with that, Dom and Jeremy, thank you both for spending some time with our financial advisors listening in today.
Dom, I'll now pass it over to you to lead today's conversation with Jeremy. Welcome back. Great.
Thank you, Dan. It's great to be back on the show. Last week, the S&P 500 briefly entered into correction territory after falling 10% below its record high reached on February 19.
Given the recent pullback, many investors may feel a little bit cautious about the market. Can you help us put the sell-off into context? Sure.
And good to have you back on the call, Dom. Yeah, context is really important here because 10% corrections in markets are always a bit anxiety-producing for investors, and there are usually different events that trigger these corrections. The current correction, which started just one month ago today, has been particularly uncomfortable because of its speed.
For context, there have been 40 times in the last 60 years when the S&P 500 has fallen by 10% from its prior peak using end-of-day prices. On average, it's taken 75 days for stocks to fall 10% during those episodes. But during this episode, it's only been 22 days for stocks to fall 10% from, as we mentioned, March 19th to the 10% threshold that it reached on March 13th.
So, for sure, the sell-off has been a bit faster than your typical correction. But perhaps more encouragingly, here's a few statistics to help keep things in perspective. First, over the long run, the S&P has generated about a 10% return per year.
But remember, in 2023, the market rose 26% on total return basis, and then again in 2024, the market rose 25%, so a couple of really strong years. So far this year, even with the correction that we've seen, as of this call, the S&P is down less than 4% year-to-date. So viewed from a slightly longer lens than one month, recent equity market performance has been far from a disaster.
Two, I would say, is that the average peak-to-drop decline in the S&P 500 in years that the market ends with a positive full-year return is right about 10%. So that means even in bull market, 10% drawdowns are the norm, not the exception, during any given year. And then lastly, it's important to remember that not only are 10% declines fairly normal, but that more times than not, they represent good buying opportunities.
Of course, the real fear is that the market decline doesn't stop at 10% and that investors could experience a bear market, which is typically defined as a fall of 20% or more. But the historical data suggests that most corrections don't turn into bear markets. So of those 40 10% corrections that I mentioned, in 28 of those 40 episodes, the market decline did not reach 20%.
We didn't enter a bear market. And the average 12-month forward market return for stocks after the market was already down 10% was 18.7% when a bear market was avoided. And even in the 12 instances when stocks did end up sliding into a bear market, the average 12-month return for stocks after those 10% corrections was minus 7%, although the peak-to-drop declines were obviously larger since we entered a bear market.
So at least gauging from history, there's a 70% chance that 10% corrections don't turn into full-fledged bear markets, and that these data suggest that staying the course and buying on dips is generally a good idea, particularly for longer-term investors. Thank you, Jeremy. I think it's always helpful to put it a bit more into perspective.
So now let's dig a little bit deeper. What have been the drivers of this pullback, and can you maybe highlight how it's evolved? Yeah, I gave a lot of general historical data, but I didn't really talk about what's been happening in the here and now, right?
So as I mentioned, this correction evolved fairly quickly compared to most historical corrections, but I'd say there were two main triggers that have caused investor concern. First and foremost, and the one that grabs the headlines is the new administration's volatile actions and proclamations on trade policy and on tariffs specifically. Taking a step back, after President Trump was elected back in November, the market rallied on the hopes and expectations that the new administration would deliver a more business-friendly climate and would prioritize extending lower tax rates for both individuals and businesses, and would focus on broad-based, cross-industry deregulation, which would have been more market-friendly.
But what has transpired over the last six weeks or so has been that an extension of the tax cuts and deregulation has taken a backseat to both the implementation of tax on both economic foes, such as China, but also on allies, such as Canada and Mexico. So both the level and the proposed tariffs, I'll call it lack of consistency with the on-again, off-again announcements on tariffs, has simply created a climate of uncertainty regarding the rules of the road for many businesses. There's also been a lack of clarity on the ultimate goal of the proposed tariffs.
And so what I mean by this is that investors still aren't really sure if the new administration is using the threat of tariffs more as a bargaining chip to ultimately reduce foreign trade barriers for U.S. exports, or if they're meant to be a new structural element of U.S. trade policy to raise government revenues and promote domestic production. So as a result, economic policy uncertainty has spiked. We see this in the higher level of equity market volatility and lower equity prices, but we also can measure economic policy uncertainty using an index that's been created by professors at the University of Chicago called the U.S.
Economic Policy Uncertainty Index. And gauging from that index, its most recent measure shows that the current level is the second highest in history, only behind the early stages of the COVID-19 pandemic. I would say that the second driver of the market's decline has been simply just the rotation that we've seen out of U.S. stocks into international stocks.
You know, heading into the year, the market was really focused on themes of U.S. exceptionalism, and even in an environment where tariffs would be implemented, it would be a bigger negative outside of the U.S. relative to the U.S. But we've seen a big pivot in Germany specifically, Europe's largest economy, which has focused on greater fiscal spending on defense and infrastructure. And so given that investor positioning is so one-sided, favoring the U.S. going into the year, the incremental concerns about U.S. tariffs and better news on European growth prospects has also led to flows out of U.S. stocks and into international equities.
So, Jeremy, as you said, given the here and now, how are you thinking about fundamentals? What are some of the signpoints we should look at in this climate to ease? You know, when we look at what has actually happened to the real economy so far, markets fundamentals still look relatively healthy.
I'll place a caveat on that statement that most of the hard data that we monitor is somewhat backward-looking, and that much of the soft or survey data that actually has weakened is not always a reliable indicator of future trends. But let's start with what matters most for stocks, and that's corporate earnings. The fourth quarter earnings season, which was just, you know, winded up and ended up over the last couple of weeks, was healthy.
What's wrong? You know, S&P 500 companies delivered earnings growth of about 10 percent year-on-year. Forward-looking estimates for the first quarter have drifted lower a little bit, but still indicating earnings growth of about 7 percent year-on-year.
And regarding the economic data, we've seen, you know, a little bit of a slowdown in the labor market. That was largely expected. But nonfarm payroll still averaged about 140,000 jobs per month in January and February.
And initial job reclaims have remained fairly steady as well. Labor income is still growing nicely at about 4 percent year-over-year. So overall, you know, core fundamentals for, you know, the economy and the equity markets, you know, maybe incrementally slowing a little bit and not, you know, not really flashing any bright signals.
In terms of signposts to turnaround market sentiment, I would put them into two buckets. You know, first is to watch for, you know, any improvements in trade rhetoric or action. And so one important date on this is going to be April 2nd.
The U.S. is pursuing a policy of what is called reciprocal tariffs. And it's set on a timeline such that on April 2nd, tariffs will be raised to levels that are equal to other countries' tariff and non-tariff barrier treatment of U.S. imports. So most likely, this date will start a series of negotiations that may or may not include, you know, raising tariffs on that date.
And the key question will be whether higher tariffs will be implemented right away or whether they'll be delayed to allow time for countries to negotiate down tariff rates with the U.S. and other countries clearly will be incented to deliver some concessions to avoid large tariffs being placed on their exports to, you know, one of their larger markets in the United States. Any delay in subsequent lowering of trade barriers would clearly be a positive for markets. Alternatively, though, we could see tariffs be implemented right away on April 2nd.
And potentially, tariffs rates could even rise further if other countries dig in their heels and retaliate in a tit-for-tat trade war. So while the outcomes on trade remain hard to forecast, at least we should see more information in the coming weeks after that April 2nd deadline. The second area that I'd be focusing on is really just watching closely the economic data to determine how much of the policy uncertainty is seeping into the real economy.
You know, we'll see personal spending and income data in the last week of March. And then the first week of April, again, similar to the April 2nd deadline, is also a big week for economic data releases with both the IFM manufacturing and non-manufacturing surveys being released that week, as well as the March non-farm payrolls. And, you know, really at the end of the day, you know, labor, you know, consumption and consumer spending drives the U.S. economy and labor income from the, you know, from jobs and non-farm payrolls is what drives, you know, the consumers, the consumer spending.
And then lastly, I would just say, you know, we also will start to hear from companies towards the middle of April with first quarter earnings season kicking off. The banks usually report early in earnings season and Friday, April 11th will be a day that we'll get many of the larger U.S. banks and we'll get, you know, an early take from, you know, bank CEOs on how tariffs are or policy uncertainty more broadly is infecting their companies at a micro level. So what I gather, you're going to be quite busy over the next couple months or so.
No vacations planned for a couple of months. So now switching gears for a bit. So artificial intelligence has been driving the market excitement, right?
Over the last few years, growth stocks have really dominated. However, growth stocks have had a bumpy start to this year, leaving many to wonder, is the AI trade dead? So Jeremy, what are your thoughts on this?
The growth stocks have lagged value by about 10 percentage points to start the year. So, yes, it's been bumpy. But keep in mind that growth stocks outperformed value stocks by over 50 percentage points in the two years prior.
So in 2023 and 2024 combined. So some of this weakness is perhaps shedding some of the froth and some of the recent year's big winners. But more specific to AI, you know, the pullback in tech stocks levered to AI was initially triggered by the emergence of low-cost AI models, such as China's DeepSeek reasoning model.
Investors are worried that the massive capital spending by the hyperscalers and other megacap tech companies in building out their AI infrastructure may ultimately meaningfully slow going forward if more efficient, lower-cost models can be produced that are comparable to some of the more costly frontier models. In our view, those fears appear somewhat misplaced. And we think the AI trade is far from dead.
In the history of the technology sector, cheaper computing power has historically led to more uses of the technology, not less. So more efficient AI models should ultimately lead to greater adoption of leading-edge AI applications over time. And more broad-based use of AI should ultimately require the biggest companies, as well as a wider array of other enterprises and sovereign nations, to continue to make significant ongoing investments in their AI computing capabilities.
And even over the past several weeks, after the DeepSeek revelations, large tech companies essentially validated this view when they signaled that they would be increasing their capital spending plans for this year by anywhere from 25 to 35 percent. So broadly, we think that the sell-off in AI stocks is largely overdone, but it's going to be a bit of a volatile ride as it always is with the emergence of new technologies. Thank you for those insights.
So now to close the call, what do you see the best opportunities as we continue into 2025? Putting it all together, at the beginning of the year, we were expecting economic growth to moderate a bit with U.S. GDP growth slowing from 2.5 to 3 percent to something closer to 2 percent as some of the fiscal spending boost fades and high interest rates remain a bit of a drag on interest rate-sensitive industries.
But with greater economic uncertainty triggered by tariffs, our base case is shifting a bit, and the risks are skewed to the economy slowing somewhat more than we initially expected. But we also think that a recession should be avoided given reasonably healthy economic momentum. So we're not talking about the economy falling off a cliff, but perhaps a little bit slower than the 2 percent that we were hoping for at the beginning of the year.
With stocks having already corrected, we're recommending that investors stay invested, remain fairly balanced within their equity portfolios between cyclicals and defenses, and between growth and value stocks. Within higher beta market segments, we see good opportunities in AI-related stocks, which we just talked about, but we also see good opportunities in financials. Over the next several quarters and few years, financials should benefit from an easing regulatory environment with lower capital requirements, which could trigger stronger returns and a step up in more shareholder-friendly actions like buybacks and dividends.
And then within defensive sectors, healthcare looks particularly attractive to us. The sector trades at a 10 to 15 percent valuation discount to the S&P 500, and historically, during periods of economic stress, the sector has traded at a meaningful premium to the market. So clearly, there's a potential valuation expansion should the economy end up softening more than we expect.
And then within the healthcare sector, medtech companies look particularly well-positioned. Demographics is an ongoing tailwind, and many innovative medtech companies continue to see healthy sales growth. And most companies in the medtech space also have minimal exposure to tariffs.
Okay, well, Jeremy, that's it for today. Thank you again for your insight.