Top of the Morning: CIO Strategy Snapshot - A new year

Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. We are at the start of a new year and it comes on the heels of three very good years for U.S. equities.

Now, there are always questions to be answered when the calendar year turns and this year is of course no exception. From the prospects for the U.S. economy to potential policy changes to concerns about an AI bubble, they're all top of mind for investors. So joining us for the first CIO Strategy Snapshot Conversation of 2026, I'm glad to be back with Jason Draho, the Head of Asset Allocation for the Americas with the UBS Chief Investment Office.

Jason, Happy New Year. Great to be back with you. I know a lot has happened over the past few weeks.

We've taken a bit of a holiday break, but it's great to be back with you here at the start of January to keep our listeners and their clients informed on a range of market and macro topics. So welcome back, Jason. Good morning.

Well, thank you. It's great to be back and after a few weeks of break. Happy New Year to you.

Happy New Year to all our listeners. Looking back at last year, certainly a good year for the financial markets, despite all the activity. And, you know, I think this could be a similar story for 2026.

So with that, Jason, let's level set here at the start on the investment environment as we're beginning 2026. Starting with the U.S. economy, Jason, what is its current status and what's the outlook from here? Well, I think if we look back to the economy for all of last year, it performed better than expected, or in some ways you could say it actually performed as expected at this time of last year.

It didn't perform much better than expected, given what happened with the tariffs being higher than investors initially anticipated. So just for context, this time last year, the consensus forecast for growth was about 2.1%, 2.2% for the U.S. economy. We don't have fourth quarter data yet, but it looks like given the data we do have for the first three quarters and sort of some of the tracking estimates for Q4, that we're going to come in around 2% this year, give or take a little bit.

So ultimately, the end destination is pretty similar to what was expected, but the path to get there was certainly unexpected. So it's ultimately a decent year, if we look at some of the data that we have for the fourth quarter. The story that we can take away from it is that the consumer continues to spend.

They're holding up relatively well. We also see that investment has been relatively narrow, it's been focused a lot on AI, there's a lot of uncertainty. That's been a bit of a drag.

There was certainly policy uncertainty in the fourth quarter because of the government shutdown that lasted well into November. That will end up being a drag on growth, so we'll probably get a bit of a moderation in Q4 growth relative to Q3, but that sets up an environment where growth could accelerate and it's likely to accelerate, especially in the first half of this year. We know that going into this year, that because of the policy impact of the one big beautiful bill, there'll be higher tax refunds than sort of normal.

Their estimates vary, but it could be anywhere between $1,000 to $2,000 higher per person than average. There's also incentives for companies to accelerate investment through different means, like through expensing. So, we'll have to sort of pick up in investment spending, especially in the first half of the year.

Financial conditions overall are relatively loose, and that tends to be kind of a positive. It's partly a response to Fed cutting rates in the second half of last year, it also reflects a weaker dollar, it reflects high credit spreads, it reflects higher equity prices, and that should be a tailwind for growth. So, we could definitely see growth in the first half of this year, especially later in Q1, accelerate.

It may moderate in the second half of this year, but that's kind of the backdrop we have. In some way, the real risk to this and the uncertainty is we've had a labor market that's been characterized as a no hire, no fire labor market, where hiring remains relatively weak, but layoffs remain relatively low. This could sort of improve from here, or it could actually get worse.

You can only sort of stay in that environment for so long before things kind of tip over and you run the risk of slowing materially. So, I'd say the big picture is better than expected growth last year, probably a bit of a thought patch to some extent in the fourth quarter just in terms of the data, but the policy environment suggests growth is likely to accelerate this year, especially in the first half. On inflation, inflation ended the year higher than was expected at the start of last year, because tariffs were higher than anticipated, and that tariff effect is likely to continue to work through at least to the first few months, probably the first half of this year, so year-over-year numbers may actually peak, not until some point in Q2.

But if you strip out the tariff effect, the story from inflation last year is that it actually was continuing to trend lower. We saw that in the non-shelter core services, which tends to be less impacted by tariffs and imports. We saw that in shelter inflation, which is trending lower and looks like it will continue to trend lower.

So, ultimately, the inflation story, I think it looks constructive, even if the headline numbers get worse before they get better. So, all in all, the economy is entering this year on a solid footing, not great, there's definitely signs of stress, and it's a little bit narrow in terms of what's performing well. But because of this policy environment, because uncertainty should come down, the outlook for 2026 looks relatively constructive from a macro perspective, at least for the U.S. economy.

So, Jason, let's maybe expand a bit specifically on the policy landscape, there's a lot there to cover. So, can you share with our listeners, our clients, your expectations from the Fed for monetary policy in the year ahead, as well as what we may expect to see from the Trump administration? Well, if we go back to December, the FOMC meeting on the 16th, they ended up cutting rates.

It wasn't maybe quite as of a hawkish cut as markets anticipated, but it's kind of a clear signal from Fed Chair Jay Powell that they're likely to take a bit of a pause, assess the data, see the state of the economy. But there's still a clear indication from the committee, and this came out of the FOMC minutes that were released last week, that there's still a bias towards easing. So, our view is that the Fed will cut rates one more time, and Q1 likely March, they probably won't have enough data to justify another cut at the end of January.

But we think they'll cut once more because the labor market soft is still sort of warrants the cut. The pulse still looks like it's at the high end of neutral, so there's justification for another cut. Given the Fed doesn't do anything this month, that's our assumption, the real focus for now is on who does President Trump nominate to be the next Fed Chair.

He said towards the end of last year that the announcement should happen in January. It could be almost any day now, and that will signal, obviously, who the next chair would be, but also an indication of what could be the future direction of monetary policy, what to nominate, officially doing testimony before Congress, but also certainly will be out there, and any comments will be closely scrutinized. It was interesting, back in early December, it looked like Kevin Hassett was the clear frontrunner.

There's media reports suggesting that. Prediction markets had his odds of being nominated at like 75, 80 percent. That's dialed back, and now prediction markets have almost a tie between Hassett and Kevin Warsh, who was a Fed governor before, but really, it seems to be very much an open contest at this point in time.

The real question is whether this changes Fed policy, and without a significant change on the rest of the committee, I think that the policy-stating framework that the Fed follows is unlikely to change that much this year. There would certainly be an expectation that you'll have a Fed chair nominee from President Trump. Bias towards cutting rates are one easier policy, but interesting, Kevin Warsh, in the past, has been pretty critical about the Fed, about its balance sheets, taking that to the sanctionary.

He doesn't seem like someone who'd be particularly dovish, so I think that's kind of, it indicates that the thought that some of the Fed will turn very dovish, cut rates aggressively, I think that that's a little bit premature. It is going to very much depend on what happens with the economy. So that will be key focus in the next few weeks, who's the nominee, where's the data, what indication do we get for the Fed cutting late in this term, or this quarter, and then the focus will be on what is the Fed likely to do late this year, and that's once the nominee is out there, does testimony, then we'll get a better sense of perhaps how that might change.

That's monetary policy, pivoting to fiscal policy and other policies from the Trump administration. If you compare it to last year, where you had, obviously, the tariff announcements being very significant, passage of the one big beautiful bill being significant, this year looks like there'd be kind of smaller tweaks at the margin. The first thing that could materialize is, on tariffs, is that the Supreme Court is likely to rule either at some point in January or early February about the legality of the IEPA tariffs.

It looks like, well, again, the prediction market suggests that they would rule against them, so the question will be, what does the Trump administration do? Do they use a temporary measure where they can pose a 15% tariff for up to six months? There's certainly in the pipeline sectoral tariffs that could be selectively employed across different industries or different countries for different reasons, which have a strong or a legal basis, but how much does the administration want to rebuild the tariffs at this point in time in a year where this midterm election is coming up?

In addition to this, is there a renegotiation of the USMCA free trade deal? Some concerns, in some parts, that the deal could be scrapped entirely, that Trump and Kim could walk away, but if not, what does it look like in terms of renegotiation? So that will be something that, again, probably more at the margin than a dramatic change.

Other fiscal policy measures are likely to be very marginal, like the tariff-free breakcheck that might make for good headlines, but I think the reality of any sort of fiscal package that is stimulative is going to probably have a difficult time getting through Congress at this point. If anything, given the concerns about affordability, concerns about inflation, what we're likely to see is sort of tweaks at the margin from the administration that are more, I'd say, supply-side focused, trying to do what they can to lower costs. We saw that with tariffs on certain food imports last fall were eliminated.

Over the holidays, reports of like even pasta, certain pasta from Italy, those tariffs being reduced. So I think there'll be selective measures along those lines. I think that's likely to be sort of a smaller-scale scale from what we're getting from the Trump administration, with the Fed, again, being thought of as a bigger focus in terms of policy measures this year.

All right. So a lot there with respect to the policy landscape to be mindful of in the months ahead, and it will be interesting to see if we have any clarity as to who the next Fed chairman will be in the coming days, perhaps weeks. Now, Jason, we've covered the macro outlook.

However, what are some of the overarching themes of the macro outlook? I mean, what are some of the things that you're looking at? I mean, what are some of the things that you're looking at?

I mean, what are some of the things that you're looking at? Well, I'll kind of put it down to three kind of general themes that I think are most relevant from a macro perspective. One is this notion of kind of running hot.

This has been a kind of a common terminology with the financial markets for the past couple of months, the idea that policymakers, Trump and his administration specifically, will try and run the economy hot, kind of do what they can to boost growth, to have a strong economy going into the midterms, given that the approval ratings on the strength of the economy, given the labor market is kind of soft right now. I think this idea that this is going to run the economy hot. Do they actually try and follow through with this, given that it has concerns about inflation and affordability?

Is it even feasible for them to do that? So I think that's kind of one kind of theme that I'd focus on, running hot. Will they or won't they?

Sort of a related idea in my mind is to think about, is this story going to be a story about kind of demand or supply? And demand, meaning aggregate demand for the economy overall, because of the one big beautiful bill, there'll be, as I mentioned earlier, higher tax refunds. Consumer spending could be strong.

AI CapEx investments continue to exceed expectations. Could that happen again this year? Could you get sort of strong demand there?

All these things suggest that perhaps the economy could accelerate even more than expected because of demand reasons. That's positive for growth, but it also tends to be more inflationary. On the supply side, the question is, what is the supply for labor?

What is the supply in terms of productivity enhancements from AI? Will it mostly be, the AI story is mostly about investments? That is kind of inflationary, driving also power prices.

Or will we actually start to get the benefits from AI in terms of productivity enhancements, which are disinflationary? But if that materializes, does it actually reduce the demand for labor? And therefore, labor demand remains weak.

So this idea of kind of aggregate supply or aggregate demand, what is the more dominant story for this year? I think that will have key implications for the macro outlook. And then the third kind of overarching theme is this kind of idea of great power competition in a multipolar world.

The events over the weekend regarding Venezuela, I think it's sort of an example of the U.S. sort of exerting its influence in the Western Hemisphere on the Americas. It's already raised questions about China and what that increased their willingness to take action against Taiwan. You could say the action on Venezuela is focused more about, you know, getting access to oil reserves, other critical minerals, again, sort of securing supply chains and key resources for the U.S.

Could China do the same? So I think this dynamic will play out in different ways. It's played out over the past year in terms of technology, played out now obviously in access to resources in some capacity.

So I think that is a key element of this kind of great power kind of competition, multipolar world. How does that sort of things at a very kind of global macro level? Now, Jason, just focusing in on the markets for a few moments, reflecting back on 2025, we didn't quite get a Santa Claus rally with the S&P 500 falling the last week of the year.

And the markets have been range bound for a few months now, yet the overall performance for 2025 was very good. How would you, Jason, describe the market set up as we're entering 2026 here? Well, I think from a fundamental perspective, I think it's relatively constructive.

The markets obviously performed very well last year. The total return for the S&P 500 around 17 percent. Equities outside of the U.S., emerging markets closer to 30 percent, Europe in the low 20s percent range.

So very good returns. Interest rates went lower. Credit spreads tightened further.

So even fixed income had a good year. So it is a high sort of base on which to make comparisons for this year. The thing that's interesting is that investors are optimistic about this year in terms of the macro.

I think what I laid out in terms of a growth outlook, inflation outlook, the Fed outlook is relatively kind of in line with a lot of investors' thinking at this point in time. Yet a sort of cautious optimism in that I'd say investors are kind of risk on positioning, but it's selectively so. Worried about things being sort of elevated at overall levels, valuations being somewhat stretched, the geopolitical uncertainty.

So I would say investors are cautiously optimistic. That's how they're positioned. A variety of position metrics.

So we're not saying this is conducive to full on embracing kind of a risk environment. That these kind of some of the various concerns out there means that there's at least a little bit of caution in terms of how investors are positioned when you try to get into an assessment of what markets are pricey for different scenarios. If anything, I'd say that the macro environment, if the risks are skewed in some ways to the upside, I think there's a scenario where you can make that case.

The markets are not really going to price for better than expected growth. That's closer to 2.5% versus 2%. So I think all that is suggested for those concerned about the markets being and getting frothy.

I think that's not necessarily what investor position would indicate, nor is it really kind of consistent. Market price is not consistent with fabulous Goldilocks economic conditions. I think it's price for good conditions, not great conditions.

And I think the latter could actually slowly materialize. So even though this is the third year in a row we've had very strong equity market performance certainly in the US, it doesn't necessarily mean that we're set up for a fall from this point. I think we've easily got like a fourth year of very good performance.

Not bad is what we expect. Now, Jason, just related to the market set up, I recall our conversations, especially during the latter part of 2025, a lot of talk about an AI bubble reminiscent of the dot com bubble. As we sit here in January of 2026, Jason, what is your assessment of AI bubble risk?

Simple, I'd say we're not at this point in time at a bubble conditions, but the possibility that we can enter them is there. I think the easiest way to think of it is like a comparison to the 1990s and the peak of the bubble was really at the end of 1999, like the last quarter, the first quarter of 2000, where I think it just sort of went almost vertical. If you look at the NASDAQ, we're not at those levels.

That's so much more closer to like a 97 type of environment. And there's different ways in which you can slice the data to tell a story, and it depends on your perspective. But when I look at the overall performance and what you typically get with bubbles and how much the markets or different asset prices rise, we are kind of halfway up those levels.

So there's certainly scope for more appreciation, but it's not extreme. Valuation metrics are unique and not at the levels that we saw back in 2000. They were definitely elevated, but it's also been driven a lot by earnings growth.

Even last year, that 17% or so total return for the S&P, only about three percentage points were due to valuation. The bulk of it, the majority, was due to earnings growth. That is your 1% in dividend yield.

The simple way to think about it is the forward multiple at the start of last year was at 21.5. This year, it's starting the year at 22. So a little bit more expensive, but not extreme.

So those, none of the valuation metrics, the performance metrics, don't really indicate it. Other conditions that tend not to be maybe focused on as much, but if we look at more of the macroeconomic fundamentals, we look at the 1990s as that comparison to the dot-com era. What is often not fully appreciated is that there was a massive investment boom during that period of time.

Funding, they built it out of the internet infrastructure, built out fiber optic cables. The investment that's taking place now with AI is a low percentage of GDP and economic activity versus what happened back in the 1990s. And it would have to increase quite a bit to get to those kind of levels.

So we're not seeing this level of fraud in its investment. Profitability actually peaked in around 97. It started to decline.

We're not seeing profitability metrics, whether it's a few hundred companies or broader companies across the entire economy, any sort of real slowdown in its profitability measures. Corporate borrowing rose a lot in the 1990s. What's often not appreciated is high yield spreads and reached a low point in 97 before widening for a few years.

We're having or are seeing a pickup in borrowing to finance AI investment, but it's still at a much lower level and balance sheets overall at a much healthier level than they were back in the 1990s. And there's other global factors that also kind of helped fuel the U.S. In 97, there was the Asian crisis, where there was an Asian currency crisis.

In 98, there was a Russian crisis. So a lot of capital was flowing into the U.S. We're not seeing the same kind of global crises that would flow money to the U.S.

In fact, this time last year, there was this idea of U.S. exceptionalism. Money was coming in. Now, if you look at flows, they've not necessarily reversed, but they've definitely kind of been more moderated, given the overall geopolitical environment.

So the macro conditions that were also critical to leading to that dot-com era bubble, those are not in place now. So this is not to say that they couldn't move in that direction, and they are trending in that direction, but it doesn't make a bubble inevitable. And if anything, it means that there's probably definitely more scope for this to run longer, certainly for 2026 into 2027.

Okay. Helpful clarity there, Jason. And thus far, you've covered for our listeners, our clients, a lot of considerations when it comes to market themes and risks for 2026.

Let's close out with some positioning considerations. What are CIO's key investment recommendations for 2026? Well, I'll highlight just three main ones.

The first is to buy equities. Our price target for the S&P 500 is 7,700 by year end. That would imply close to or more than a 10% total return.

The macro conditions I've already alluded to, we think will be constructive this year with good growth, inflation coming down, the Fed cutting rates. The AI investment story, that is not a bubble. I think that there's more scope for that to continue for this year.

So equities in the U.S., but also globally, more constructive on that. Second, it's to be more selective in fixed income. We think of kind of the rates environment, the outlook is somewhat two-sided.

For rates to go material lower, you probably really need a real kind of downside surprise in terms of growth. It's a risk, not our base case. Well, there's also a risk that rates could go higher if growth ends up being above expectations and inflation doesn't moderate.

You could easily see the 10-year treasury yield go up to 4.5%. So cautious on taking a lot of kind of rate exposure. Credit spreads are tight, and now we are seeing a pickup in supply.

The fundamentals, or at least the technicals you don't necessarily offer, really support a picture for IT credit or corporate credit to take further. So be cautious on terms of fixed income exposure, at least selective opportunities. It's an environment where you probably get your carry, but not a whole lot more than that.

And the third key message is we like commodities and gold in particular. Gold, we know, was spectacular last year, up over 60%. It paused back a little bit towards the end of last year, but it requires action as of Monday morning, and it kind of reinforces the idea that gold is a good diversifier.

It's up 2.5% as of roughly 10 a.m. on Monday morning, January 5th. As a safe haven demand, as a diversifier, looking at what happened over the course of the weekend, you know, for countries that are, you know, especially emerging markets that are worried about US action, you know, you'd rather maybe own incrementally gold rather than US dollars. And gold is the beneficiary for that.

We think that theme will continue to play out this year. Well, Jason, it was great catching up with you this morning to kick off the conversations for 2026. Thank you for the refresh on CIO's market and macro outlook and for hitting on some of those key positioning recommendations from the Chief Investment Office.

And as always, Jason, looking forward to picking back up with our conversation next week. You're welcome, Dan. Have a great weekend.

Have a great year. Likewise. Thank you, Jason.

Again, today we have been joined by Jason Draho, Head of Asset Allocation for the Americas with the UBS Chief Investment Office from UBS Studios. I'm Dan Cassidy. Thank you for joining us.

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