Top of the Morning: CIO Strategy Snapshot - A better risk-reward distribution
The desk is optimistic about equities as recent trends suggest a more favorable risk-reward scenario for investors, despite ongoing concerns such as the government shutdown and potential credit events. Per the full note source, UBS upgraded its equities outlook due to improved growth forecasts, with the S&P 500 demonstrating a remarkable 33% increase since April lows. This positioning signifies a potential bullish shift in the market as analysts expect better earnings outcomes in the coming months.
What the desk is arguing
The desk believes that current equity market conditions offer an attractive risk-reward profile to investors. This perspective aligns with UBS's recent upgrade of equities in its House View, indicating a more optimistic outlook for growth and earnings over the next year.
Key evidence includes the significant rise of equity indices, such as the S&P 500's 33% rebound since April. This upward momentum is attributed to stronger-than-expected economic data leading into October, suggesting potential for further appreciation in equity returns.
Where it sits in our coverage
Our consensus target for the EUR/USD stands at 1.075 with a range from 1.04 to 1.12. Key estimates include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view places UBS's optimistic stance in line with jpmorgan, while conflicting with bofa's more cautious outlook, indicating a potential divergence in market perspectives regarding future currency pair movements.
How other firms see it
In general, firms like jpmorgan view the shift towards equities as supported by favorable growth forecasts, while bofa expresses a more conservative stance, signaling caution against potential market headwinds.
Investors should also monitor the EUR/USD trajectory, which may relate closely to these evolving sentiments in equities and overall market volatility.
01Equities upgraded to attractive by UBS due to positive growth outlook.
02S&P 500 shows 33% recovery since April, signaling strong investor confidence.
03Risks include ongoing government shutdown potentially impacting economic performance.
04Diverging firm sentiments between **jpmorgan** and **bofa** highlight market uncertainty.
Market implications
Traders should watch for further advancements in the S&P 500 as a potential signal for risk appetite. A key level to monitor is the 1.075 mark in the EUR/USD, which reflects confidence in the equity market outlook and broader economic conditions.
Risks to this view
If the government shutdown extends and leads to worsening economic indicators or credit events, this could undermine the bullish equity outlook and prompt a reevaluation of positions across the market.
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Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. Financial markets bounced back last week as U.S.-China trade tensions eased and the start of the Q3 earnings season produced good results for the large banks, but the government shutdown continues with no clear end in sight and investors are a bit anxious about other risks, including the potential for more credit events.
So joining us today for the CIO Strategy Snapshot, glad to welcome back Jason Draho, Head of Asset Allocation for the Americas with the UBS Chief Investment Office. Jason, happy Monday to you. Thank you for dropping by this morning and for spending some time with our listeners and their clients.
Welcome back. Good morning, Dan. Happy Monday.
So Jason, as our listeners know, normally we like to end our conversations with an update on asset allocation. However, today let's begin with that because last week the Chief Investment Office upgraded equities to attractive as part of the UBS House View release. So specific to this upgrade to equities, Jason, why did you decide to make that change now?
Well, the question we were asking ourselves, you know, is it the right time? Like why now? The S&P 500 is up 33% from its lows in early April, global equities, same thing, up 32%.
Ultimately, you know, I think this is really a predicate on the fact that when we assess what's changed over the past month, we think the growth outlook, the earnings outlook for well this year, but particularly the next 12 months is better than we initially expected. And that's kind of driving the upgrade in equities because it drives the view that ultimately we think there's more upside in kind of equity returns. The government is shut down, but the data we've got through the end of September, and other, some more other data points through early October that are government related, kind of paint a picture of a U.S. economy that has exceeded expectations this year, especially in light of the tariffs and what was announced earlier this year.
And if anything, it's more likely to accelerate next year rather than decelerate and growing, you know, near or even above the 2% trend rate. And if we start to look at some of the details, you know, concerns about the consumer and the health of the consumer overall, there definitely is a bifurcation between higher income consumers and lower income consumers. The data this year has been choppy, so depending on when you chose to take a snapshot of consumer spending, you could tell a more pessimistic picture.
But if we look at the most recent data we have, which is consumer or, you know, the whole overall personal consumption expenditure data, which is the broadest measure of consumer spending on a real inflation-adjusted basis, the three months through August on an annualized basis came in at about 4%, which is not a sign of a consumer that's really kind of struggling. And then real-time credit card spending data that comes into, or at least early October, you know, suggests consumer spending is holding up. Some of the big banks reported huge earnings last week.
They also suggest the consumer is holding up, and that's critical. That's 70% of the economy. Now, looking ahead to next year, there will be some stimulative benefits from the One Big Beautiful Bill.
You know, estimates are roughly, you know, 50 basis points of positive growth impulse for next year. Some of that is front-loaded because the tax cuts will take effect day one, but also some of them are retroactive. So, when individuals are filing tax refunds or positive taxes early next year, they will get bigger refunds than they normally would.
So, again, that will provide some stimulus for spending early on. AI-related capital spending has probably been the biggest marginal contributor to growth in 2025. You know, there's certainly a fear that that could slow down, but as we kind of outlined more clearly in our monthly CIO letter, the demand for kind of just AI compute, but also demand for agentic AI, the demand for physical AI, where like AI is embodied in robots and other machines, that remains, you know, very strong.
We think it will continue to be strong, and that should support AI capex to continue to rise. So, the concerns about all this investment not kind of, you know, being monetized, you know, there will be certainly some wasteful investment, but ultimately, I think that trend continues, and that investment will continue to provide a boost to growth for next year. And this better growth outlook isn't necessarily coming at the expense of higher inflation.
If you look at the inflation details, there definitely is a component that is tariff-related, and that's likely to continue to rise at least on a month-over-month basis through the end of this year, year-over-year basis into the middle of next year. But if you look at things such as your core services at shelter, that's actually been trending lower throughout the year. Even shelter CPI inflation has been gradually declining over the course of the year.
So, these underlying inflation trends suggest that that's also improving. So, the view that next year growth will be solid, if not accelerating, inflation will be coming down, all of that is, you know, kind of conducive to a higher growth outlook. Higher growth outlook leads to higher earnings.
Again, that's also why, you know, we have a higher earnings outlook, or a more positive view on equities overall. So, looking at the investment outlook, Jason, in your most recent blog, the title, A Better Risk Reward Distribution, you wrote within that there were three main considerations underpinning the investment outlook. In addition to better growth, you say that policy should also be supportive.
How so? Well, I've already mentioned the fiscal policy and the stimulus effect from the one big bill. Like, that's probably what we can be most certain on in terms of the positive growth story for next year.
The Fed should also be supportive. You know, we still expect the Fed will cut rates 25 basis points at the end of October, another 25 in December, and then once more in Q1. This is basically in line with kind of market pricing.
After that, it becomes much more uncertain. The markets are pricing for more cuts, so you could say some of the Fed stimulus is already being reflected in the markets. But I don't think it's just important to understand, like, what is the overall bias for the Fed in terms of being more accommodative or easing versus a more restrictive bias?
Last week, you know, Fed Chair Jay Powell said that the downside risks to employment appear to have risen, which, again, is sort of reaffirming his way of signaling that, yes, you are almost, you know, very likely cutting rates at the end of October. But until there's stabilization improvement in the labor market, you'll have a Fed that continues to be biased towards cutting rates. He also stated that the balance sheet reduction or quantitative cutting should end soon.
You probably won't get explicit guidance on that next week at the FOMC meeting, but probably no later than the beginning of January, where they announce the end of QT. By doing that, that is a de facto, you know, stop, you're kind of tightening, you move towards a more neutral bias, and other adjustments to the balance sheet next year could also be, again, sort of towards a bit of an easing bias. Ultimately, you know, what we think is we'll have a Fed, especially once there's, you know, change in the Fed Chair from next May onwards to someone who's probably more gubbish.
Other committee members could also shift. Lisa Cook may not stay on the Fed. That could be a position where, again, someone is more gubbish.
So all in all, our view of three cuts in total from here, I think the risk is certainly more that the Fed does more, like four or more, rather than two or less at this point in time. And the Fed's kind of bias will be to still be neutral to accommodating. If that's the case, that's the point of risk taking.
Another key policy measure is, you know, on tariffs, the recent escalation of U.S. trying to trade tensions, perhaps it'd be a counterpoint to policy being supportive. But that situation escalated, then it de-escalated to some extent fairly quickly. How this plays out over the next couple of weeks, going into the likely that President Trump and President Xi of China will meet at the APEC summit at the end of the month, how this is all going to play out, you know, I think our view is that this is more of a sign that we're going to get some rolling negotiations, truces, rather than a sustained escalation, which, in other words, basically the status quo.
But ultimately, I think the big picture, we think about policies, particularly U.S. policy, ultimately the onus is on growth to deal with the fact that we have high debt levels. And also looking to next year with the midterm elections for Republicans, they'd want growth in the macro environment to be better to help them. And growth could be both real growth, but also normal growth, which is a combination of inflation.
And I think where I think of it is if U.S. policy makers, and specifically the Trump administration, wants kind of higher growth next year, the lesson to get it, you know, one way or another, whether it is easing off on trade tensions, whether it is, you know, kind of being easier on, you know, or accelerated deregulation, allowing for more transactions or, you know, looking to encourage more investment in companies, I think they will kind of get that result. So, again, the risk from a policy perspective is more likely to be supportive for growth accelerated than being restrictive to cause growth to decelerate. Now, I also, Jason, want to point out in the blog, you say that investor sentiment and positioning is neither fragile nor euphoric, and is more accurately characterized as still constructive for risk assets.
So I'm curious, what leads you to that conclusion? Well, one is that, you know, there are pockets of euphoria, and all you have to do is look at certain types of sectors and stocks, such as quantum computing, that had gone almost sort of parabolic in its rise, other stocks similar to that. But it's not as rampant as it was, even during the meme stock and kind of SPAC mania in the later parts of 2020 and the first half of 2021, when there's certainly a lot of speculation going on, let alone the kind of multi-year speculation and sort of euphoria that took place during the peak of the dot-com bubble.
So we're not kind of there yet. It's also some of those more speculative parts of the markets, you know, did pull back a decent amount after the U.S.-China trade tensions flared up. So all of these baskets were down 10% in a matter of a week.
Now, one interpretation of that is a sign of the fragility of the markets and the fragility of investor sentiment. I mean, whether or not you want to believe that or not, that is sort of a subjective assessment. But in a more practical matter, what it really means is that some of the fraud that perhaps existed in financial markets, you know, is being taken out, is being reduced.
You kind of curtail some of the speculation a little bit, which ultimately is a positive for the medium-term outlook. So whatever the reason is, I think that ultimately is a net positive. You can also see data on positioning of a full range of investors from institutional hedge funds, long-only types, retail investors of different types, and how are they positioned overall.
And the kind of net takeaway is that the positioning is a little bit above average in terms of risk assets, but it's not at extreme levels. And many investors, I think, are positioned to kind of buy any dip, certainly in equity markets. And the final thing is, if you sort of believe in this sort of euphoria idea that we're in a bubble, you know, it's also unlikely that, you know, something like that would end in an environment where the Fed is cutting rates, making the cost of capital lower, or even before it sort of resumes hiking.
That's usually what we see is, you know, the Fed is telling you policy, and that helps, you know, kind of pop any sort of excesses in the market. If it's going in the other direction, that tends to be point fuel on that momentum. Now, Jason, at this point, we've covered the reasons why the outlook for equities is positive.
But what are the risks that you're most worried about at the moment? Well, there's a few that are, you know, from a fundamental perspective that I would point to. One is that, you know, the trade tensions may not escalate, they may escalate and stay that way, you know, for a period of time, and not just between the U.S. and China, but between the U.S. and other trading partners.
In early November, the Supreme Court will hear testimony regarding the IEPA tariffs that were put on as sort of an emergency measure. If they were to rule against them, then perhaps other countries will start to think, all right, well, we've waited for this. If the administration, therefore, tries to proceed with other measures, maybe now we will start to kind of push back more aggressively.
And there's a little bit of rumblings about other countries that have not been particularly happy with, you know, the deals struck, so that's certainly a possibility. And I think, well, the markets have been willing to look past, or have kind of looked past, or moved on, is the better way to think of it, in terms of the tariff story, starting kind of, frankly, in the summer. If there's more now hit to the economy, whether it is kind of a growth perspective or inflation perspective because of the tariffs, that is certainly a risk.
And there is some data that would suggest that new companies have been not passing along the higher cost to consumers, but they're going to start to do that, which would impact their annual incomes, which ultimately would impact real spending. So there's certainly that remains a risk that we're not out of the clear yet from tariff consequences. That kind of ties into the overall state of the economy, you know, the labor market softness may not just be a temporary soft patch where we see labor market growth and hiring sort of pick up next year.
This could actually be a precursor to further weakness, which would increase the risk of a recession. Obviously, there's been some events recently of credit defaults. You know, there's idiosyncratic factors to each of them, but it's not clear yet if those idiosyncratic factors add up to something that's more broad based and is a warning sign for further stress to come.
That's only to be the case. And finally, there's a lot sort of riding on kind of AI investment, the CapEx story of the monetization of that CapEx. Any event that kind of calls into question the potential return or how much, you know, investors will be rewarded from now, all that investment, you know, could cause the markets to have a pullback, especially in the AI related space.
We saw that earlier this year when the deep seek news came out, it hit tech stocks quite hard even before the tariff news really kind of materialized. That is another risk. Okay.
Good to know about those risk considerations. So at this point, we've focused mostly on equities outside of equities and the U.S. market specifically. Jason, what are some other key messages within the House View update that our listeners, our clients should be mindful of?
Well, I think I already tried to make the case for why equities are attractive in our, you know, if you have this point in time, a key message is to add equities. Just for perspective, in the U.S. we did upgrade our price targets for the S&P to about $6,900 by December, but more significantly $7,300 by next June, given the current levels. That is looking at high single digit type of total returns over the next roughly nine months.
So that's, you know, some context of what kind of return potential we see. Other key messages, you know, are, you know, kind of seek opportunities in China. With equities specifically, within that, China Tech stands out as one of the more attractive opportunities in global equities, you know, also driven by kind of breakthroughs in AI and semiconductors, you know, and just in manufacturing data and power, you know, there's been a bit of a pullback recently in China Tech, which is actually kind of a healthy re-entry point.
It's something that we like as well. But those opportunities there, that kind of parallel to some extent the opportunities we see in the U.S. Another key message is gold for gold, but gold has probably rallied more in recent weeks and months than almost any other asset class.
It looks like kind of like almost a straight line higher. This is a combination of, you know, demand for investors looking to have alternatives from sort of the U.S. dollar, but other currencies. It's kind of now part of what some people refer to as a debasement trade, as governments look to grow and play their way out of debt problems, that gold is a key beneficiary.
But gold also has clearly been a diversifier and a risk-off environment. On the day that President Trump announced that he would impose additional tariffs on China 10 days ago, on that day, equity sold off over 2%, 3%. Gold was up 1.7% that day.
So it's a good diversifier. We think it could be used to have those features. And while there could be certainly a bit of a pullback, I think that's going to be more an opportunity for investors to buy and add exposure, because gold, for a lot of investors, is not widely owned.
So it's not as if they're over-allocated. And the final message is to put cash to work. The Fed has resumed its rate-cutting cycle.
We think there's more cuts to come. It's been nice to sit on the sidelines with cash earning 5.5%, but those yields are going lower. So just thinking about how you want to deploy that across equities, but also within fixed income, tilting more towards a higher-quality fixed income, to stay in that part of your kind of relative protection, your portfolio, and take the risk more on the equity front.
Well, Jason, as always, thank you for dropping by. A productive way to begin the week. Thank you for keeping our listeners, our clients, informed on CIO's current positioning views and investment outlook.
And as always, do look forward to our next conversation next Monday. Thank you again, Jason. You're welcome.
Have a great week. You as well. Thank you, Jason.
Again, today we've been joined by Jason Draho, Head of Asset Allocation for the Americas with the UBS Chief Investment Office. I do want to point out to you, our listeners, available for you now up on UBS.com forward slash CIO. You can reference the blog, which Jason has been citing on today's episode.
That title, A Better Risk Reward Distribution, that's Jason's latest blog. Also available up on UBS.com forward slash CIO is the November UBS Houseview Investment Strategy Guide and Publication Suite. So that's all available for you now up on UBS.com forward slash CIO.
From UBS Studios, I'm Dan Cassidy. Thank you for joining us. Thank you for tuning in.
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