Top of the Morning: CIO Strategy Snapshot - Navigating volatility
The current market dynamics are being heavily influenced by renewed trade tensions, government shutdown implications, and the impending Q3 earnings season, all of which are fostering volatility. Per the full note from UBS, the S&P 500 experienced a notable 2.7% drop last Friday, highlighting how sensitive equity markets are to trade-related news. With the prospect of new tariffs and the U.S.-China trade relationship hanging in the balance, traders need to remain vigilant about market positioning. Ahead of major earnings announcements, volatility could persist as investors reassess company outlooks against this backdrop of uncertainty.
What the desk is arguing
The desk views the recent drop in equity indices as a signal of intensified market volatility linked to trade uncertainties. This comes in the wake of recent trade escalations, including proposed tariffs that could significantly affect U.S. import costs. Per the full note, Jason Draho highlighted how the return of trade discussions can shift market sentiment swiftly.
Evidence of this heightened risk is reflected in the decline of the S&P 500, which interrupted a three-month strong performance. The index had risen over 15% year-to-date before the downturn, illustrating the fragility of current market optimism. The current positioning from asset allocators suggests a cautious approach given these developments.
While some investors may interpret this volatility as temporary, the desk believes that sustained trade uncertainty could lead to more aggressive market reactions, particularly as earnings season unfolds.
Where it sits in our coverage
Currently, our consensus target for the relevant currency pair sits at 1.075, with a range of 1.04 to 1.12. Specific firm projections include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This aligns with the prevailing cautious stance in light of recent economic signals, positioning our view slightly towards the upper end of the consensus spectrum.
How other firms see it
Firms such as jpmorgan hold a similarly aligned perspective towards potential U.S. trade impacts. In contrast, bofa has adopted a more bearish view, suggesting lower outcomes in the near term.
Market participants should keep an eye on correlated movements in the EUR/USD pair as shifts in trade sentiment could affect broader currency markets. Additionally, the upcoming Fed commentary is another layer that could influence market dynamics during this volatile period.
01Renewed trade tensions are driving market volatility.
02The S&P 500's recent drop signals potential fragility in recovery.
03Upcoming earnings season could heighten investor anxiety.
04Trade negotiations will be key to market direction.
Market implications
Traders should monitor the S&P 500 for signs of stabilization or further declines, watching for a key support level around 4,200. The ongoing trade negotiations and any resultant tariff announcements will likely also dictate market movements in the FX space.
Risks to this view
If President Trump and Chinese officials fail to agree on tariffs or the proposed meeting falls through, significant escalations in trade tensions could lead to deeper market corrections. Additionally, a rapid resolution of trade disputes could also significantly alter the outlook, reversing current expectations of volatility.
ubs
Hi everyone, Siobhan Chapman here and welcome to Top of the Morning on the UBS Market Moves podcast channel. Tariffs and trade tensions resurfaced at the end of last week and the result was S&P 500 falling 2.7% on Friday. The decline interrupted a rally that had taken the S&P 500's year-to-date rise to more than 15%.
The prospect of more trade uncertainty, the ongoing government shutdown, and the start of Q3 earnings season are all things that investors have to grapple at the start of this new week. Here to discuss all of this is Jason Draho, head of Asset Allocation Americas. Jason, let's get started.
We'll start with the latest developments on U.S.-China trade. What happened and where do things go from here? Well, it's been an eventful, let's say, three or four days.
It began with last Thursday, China announcing stricter export controls on rare earths minerals. That led to President Trump announcing on Friday additional measures, including 100% tariff on all imports from China, effective November 1st, and export controls on critical software. So it had been a relatively calm truce for a number of months, maybe uneasy, but that suddenly erupted at the end of the last week.
President Trump also said that he would consider cancelling a planned meeting with the President of China at the APEC summit in early November. That's where things lanced on into Friday, but there was de-escalation of tensions over the weekend. On Sunday, China signals a softer stance through a statement from the Ministry of Commerce that came out on Sunday, saying that the export controls are not a ban, your compliant non-military rare earth exports will be approved, and its new rare earth policy was a reaction to additional U.S. restrictions instead of a proactive escalation.
Shortly after that statement was put out, President Trump posted on social media, don't worry about China, it will be fine, and he also clarified comments that he still plans to meet President Xi at the end of October, beginning of November. Also, Treasury Secretary Scott Besant and the Vice Premier of China, Le Feng, are also potentially going to meet in Frankfurt in a couple of weeks. Some signs of de-escalation, we can see the markets are going to respond, at least U.S. futures markets are responding favorably as of Monday morning.
How to interpret these kinds of escalation, it's certainly possible that both sides are trying to get to the table, get some leverage ahead of the negotiations that will take place over the next month, given that the current tariff pause expires on November 10th, so this could also just be a negotiating tactic leading up to the potential extension. Ultimately, we still think a full-scale trade war between China and the U.S. is unlikely, and both countries are going to seek some sort of concessions and want to avoid a disruptive trade dispute with one another. It's in neither side's economic interest to see this escalate, but of course, both sides want to get the best possible deal they can, so it's understandable that these tensions potentially kind of flare up.
Things to watch for between now and the end of the month is confirmation of a meeting between President Trump and President Xi, maybe clearer definitions of what is critical software, what sort of exemptions could take place, any other semiconductor-related tariffs under Section 232 could be key things to watch, but at least from the moment right now, it does seem like the escalation of tensions on Thursday and Friday have de-escalated to some extent on Monday morning, but this could be sort of the backdrop and sort of tension points that continue to exist for the next month until we get either a further extension of this pause, which is likely, or some sort of escalation in about a month from now. The market reacted negatively to the news, but S&P 500 futures are pointing higher this morning. Was Friday just a small speed bump in this climb higher, or was it a warning that there will be more volatility ahead?
Well, as you mentioned at the outset, the S&P 500 was down at 2.7% on Friday. The Nasdaq was down even more at 3.5%. It was a fairly kind of classic risk-off day.
The 10-year Treasury yield fell eight basis points, the two-year yield fell six basis points. Gold rose 1% as our risk-off hedge, although the dollar did decline 60 basis points, kind of reflecting the fact that as a state, even the dollar's attractiveness has been diminished to some extent, and effectively gold is benefiting from a kind of a de-dollarization trade overall. What's also interesting is this kind of, in the context of a lot of chatter in recent weeks about the potential for a market bubble, things that we're getting, signs of speculation, worried about whether the AI investment that's kind of driving much of the markets, will this actually be ultimately warranted by earnings down the line?
And there was definitely some signs of more speculation in the markets, little pockets of froth here and there, feeding into the concerns about a potential bubble forming. What we saw on Friday was a little bit of air coming out of the pockets, so to speak. In addition to the overall equity markets down being quite a bit, if you look at certain parts of the market, like unprofitable tech stocks, baskets of these were down 8%.
AI tech beneficiaries were down 5.5%. Things that were more speculative fell quite a bit. Cryptocurrencies declined ultimately over the course of the weekend, upwards of 10 plus percent.
In addition, volatility that had been relatively contained, it also spiked on Friday. The VIX volatility index for equities was up 5.5%. You normally, the ratio should be closer to one for one, meaning the S&P was up or down 2.7%.
The VIX would be down about 3. You saw a bigger surge in volatility, again, consistent with perhaps some signs that investors have become complacent or volatility has been suppressed because investors are using futures or options to get the upside exposure, less worried about some sort of downside. That was a little bit of the air out of the bubble narrative that came out on Friday.
That's not a bad thing. It's probably a healthy development. But if we continue to get unexpected developments on the policy front, a longer U.S. government shutdown than expected, further escalations in U.S.-China trade tensions, or at least the de-escalation doesn't actually hold, all these things could add to the sort of more kind of volatility in the market, at least in the near term, especially since the market's been on a pretty much straight line higher for the last six months and especially over the last six weeks or so.
The third quarter earnings season starts this week. And in the absence of government data, the results could take on even greater significance than normal. What are you expecting from the results?
Well, the main earnings season starts on Tuesday, the 14th, and it'll be led by financials as is typical. And this week, we will get about 12 percent of the S&P 500 market cap reporting, dominated by banks and by financials overall. Going into the earnings season, consensus analysts kind of forecast, expect a deceleration from a really strong Q2, where there was 11 percent year-over-year earnings growth for the S&P 500, up to falling down to 8 percent year-over-year in the third quarter.
One interesting aspect about this earnings season, or at least coming into it, is that there was very little cut in kind of the bottom-up analyst expectations for the earnings season. Typically, if you take from, say, this case, July 1st, through the earnings season until companies start reporting in mid-October, during that sort of typical three-and-a-half-month period, analysts will ultimately kind of cut their expectations in aggregate for the S&P 500 by about three or four percentage points. But since the start of the third quarter, the third-quarter earnings estimates have basically flatlined, meaning there's no real cut in earnings expectations over the last three months.
Now, also, in the context, the way that kind of the pattern works is that analysts end up cutting their expectations around three-ish percent. Companies ultimately beat by three to four percent, and so relative to where consensus was as of, let's say, July 1, the number often is that they beat, the company ultimately beat by one percent, but three to four percent relative to the revised expectations. Right now, we just now have that down revision.
That does leave maybe some concern about the bar is now higher. Typically, it declines. And if it's higher, there's more scope for disappointment.
But it is the case that, you know, the lack of down revisions doesn't necessarily, isn't a negative sign. It's actually often more often than not sort of a bullish sign. So, basically, in the last 25 years, the median S&P of 100 company earnings per share beat estimates, you know, by up to around, like, five percent on average when there was no kind of downgrading and revisions versus, you know, the typical beat of about three percent.
So, bottom line, the lack of cut over the last three months is actually historically kind of a bullish sign for the earnings season. Obviously, time will tell when you see the data. But also, guidance for Q4 over the past month, the past couple of months, has been, you know, immodest.
It's, you know, no real cuts thus far. So, we're setting up between the lack of, you know, downgrades for Q3, the lack of downgrades so far for Q4, and it's still very early, suggest that the earnings season for Q3 and also ultimately the kind of guidance for Q4 could be, you know, relatively constructive for equities. And we'll start to get more information beginning on Tuesday.
So, we are coming to the end of our conversation, Jason, and I want to discuss investment recommendations. Given all that's going on, what should investors be doing right now? Well, we saw on Friday, you know, this is kind of a little bit of a speed bump for equities.
It is ironic that there are some risks out there that investors shouldn't get too complacent. But ultimately, if and indeed this was a bit of an escalation now, de-escalation in the course of, you know, two business days, and we see equity futures going higher, that ultimately kind of reaffirms our view that, you know, the bull market for equities is intact. There'll be some hiccups every now and then.
Pullbacks represent an opportunity for investors who are under allocated equities to add some long-term exposure. You know, given the fall on Friday of being down, you know, 2.7% for the S&P, and a bounce back this morning, you know, could be like futures indicate about 1%, that's not exactly a major pullback. But, you know, the bigger picture point being that pullbacks are an opportunity to add exposure.
One of the areas that we'd like is financials and banks specifically in financials, and we will get companies reporting this week that will give some of that guidance. And so, there's certainly scope for our view is correct in terms of how they're performing, how they will perform in an environment where the economy is holding up. And you know, some tailwinds from sort of deregulation, we expect them to kind of be outperformers.
And that could be kind of give it a bit of a bounce this week, especially because banks and financials have underperformed the markets at least a little bit over the past, you know, two to three weeks. You know, technology and AI continues to remain a key theme. The fact that, you know, there was a bit of de-escalation of voluntary attention sort of reinforces the view that there's only so much that either side, you know, the U.S. or China wants to engage in terms of restricting, you know, the flow of technology, because AI is a critical area for now for both governments.
And part of that thesis, you know, that view is that we need to maintain a kind of a balanced view of the overall AI kind of technology stack from enabling to intelligence to application layers. And we have a positive view on both the prospects for U.S. and China tech over the medium term. So corrections like we saw on Friday, these are the opportunities to potentially add exposure if you are under allocated.
In terms of fixed income, we have a preference for higher quality, especially securitized credit over corporate credit. There has been some pockets of stress in credit markets with, you know, high profile defaults for spreads, for tricolor. It is highly the fact that spreads are very tight, that there is, you know, decent credit risk out there, not elevated, but decent credit risk.
And it doesn't appear to be that when it comes to corporate credit, investors are getting fully compensated for that. So overall, we're sort of tilted towards, you know, higher quality fixed income, more prevalent in securitized credit where the spreads are a little bit wider, sort of therefore I think investors are getting a little more compensated for that risk that they're taking. And then gold continues to be a good diversifier in its performance on Friday in this risk off environment, where gold rallied when the dollar fell, that is consistent with the idea that gold can provide a good diversification in these broader sort of risk off periods.
But also on a longer term basis, as investors globally look to try and reduce exposure to dollar in particular, gold is one of the key beneficiaries. So we think it will continue to have a strong tailwind going into the rest of this year and into 2026. Thank you so much for joining us, Jason.
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