Top of the Morning: CIO Strategy Snapshot - Second half outlook

Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. We are at the midpoint of 2026 and days away from the 250th birthday for the United States of America.

It has been a good first half for investors providing plenty of reason to celebrate on the July 4th holiday. However, as we head into the holiday and the second half of 2026, equity markets have been volatile. The Fed has shifted to a new communication regime and AI continues to be the dominant market driver.

So joining us here to talk about this all and to provide an investment outlook for the second half of 2026. Glad to have back with us today for the CIO strategy snapshot, head of asset allocation for the Americas, Jason Draho. Jason, good Monday morning to you.

Thank you for dropping by. Good morning, Dan. Happy Monday.

Good to be here. So Jason, let's begin today with the markets and how they've been performing as of late. There's certainly a lot of volatility in the market.

So from your vantage point, what's been causing this price action? Well, at the midpoint of the year, it's worth noting first that it's been a good year so far for almost all asset classes. With the S&P 500 sort of total return about 8%.

Global equities, almost 9.5%. Bonds up low single digits, but a positive year. So good performance across the board.

If we look, though, more recently, after a really strong rally in April and May, the month of June has been somewhat choppy. We've seen some pretty big swings almost day to day basis. And just if we take last week, this is the week of June 22nd.

What we saw is the S&P 500 was down almost 2% for the week, but an equal weighted S&P 500 index was up about 1.6%. If we look at the NASDAQ 100, it was down 4.5%, whereas the Russell 2000 small cap index was up almost 1.5%. Some pretty big divergence, you know, kind of going on overall.

And then if we were to look at the MAG 7, if you're going to equal weight them, you know, they were down 6% last week, whereas the remaining 493 stocks in the S&P were up 70 basis points. So what was driving this? What's causing sort of big divergence in volatility?

Well, certainly the macro. You know, the macro has been holding up relatively well. It's not the Fed.

We'll talk more about the Fed, but it's not necessarily sort of the Fed communication. It's not even necessarily the, you know, ceasefire deal that the U.S. and Iran signed with oil. Now, the price is falling dramatically.

We're starting to see an uptick in oil flows and the rate of firm moves. Really what's been going on for the past couple of weeks has been, you know, all about AI to various extents, AI CapEx, and kind of return on investment. And if you were to sort of bottom line it, the things that are kind of going on with an equity market is that those companies who are CapEx spenders, you know, the hyperscalers that are spending hundreds of billions of dollars to build out data centers, they've been getting sort of hit, you know, relatively hard.

Whereas those who are the recipients of all that spend, such as semiconductor companies, they've been a big kind of beneficiaries. And so this kind of has been, you know, leading to, you know, very big swings. Now you have very high margins for some of these companies, particularly semiconductor companies, which in some sense, when you have that, you have to come with a lot of, you know, operating leverage, you know, these really high margins, all taken sort of, you know, tweaks in some forecasts or assumptions or outlooks to cause, you know, revisions there, that kind of cascade into sort of, you know, really big swings.

And we've seen that contributing to volatility as the market sort of churns through and sort of assess the wealth of winners, you know, as the winners sort of evolve, you know, what's kind of going on there. And it's not just a U.S. story. You know, EM has become de facto sort of U.S. trade because it's now heavily dominated by five or six companies, you know, based in East Asia, Korea, Taiwan, China, that are AI related.

So as the AI team, you know, plays out, you see really big moves in volatility in those markets as well. In addition to all this, a lot of, you know, securities and financial instruments, including like leveraged ETFs, they're amplifying some of these moves. So the fundamental story kind of going on at the more micro level, amplified by investor products and solutions that are ultimately having sort of a market-wide, almost economy-wide impact.

So that's sort of what's been driving a lot of what's been going on. It's not actually the macro or the policy or geopolitics has really been, at least for equity markets in particular, you know, the story's really been about AI, sort of what is the kind of the wealth of winners and losers leading to a lot of volatility, a lot of sort of churn within the marketplace overall. Maybe we can talk about the Fed for a few moments.

You mentioned that the Fed hasn't been a principal source of this market volatility. However, the Fed is certainly in focus because the potential changes with Kevin Warsh as the new chair. So what are CIO's views, Jason, on Fed policy on their chair Warsh?

Well, so we, you know, had our first press conference with Kevin Warsh as the chair, now almost two weeks ago, and clearly marks a change in communication style. I think that's a fairly safe statement, given that he's not a particular fan of forward guidance. Now, one of the outcomes of that meeting almost two weeks ago was that it appeared to be the Fed has made, and the FOMC specifically, has made a hawkish pivot, meaning much more aggressive in terms of the possibility of, you know, raising rates, not only this cycle, but also as soon as this year.

And a simple way to look at that is if you take the dot projections of the 2019 committee members, what I think the Fed funds rate will be at the end of 2026, end of 2027, nine people now anticipated a Fed rate hike this year. Kevin Warsh did not provide his own dot, so we don't know exactly where he resides. And so the median person now is expected to adopt a hike this year, whereas three months ago in March, no one was anticipating a hike.

So that's a read-through of the Fed being quite hawkish. I don't know if it's an interpretation of that. We also have Warsh say multiple times during press conferences that price stability is paramount.

And you can sort of interpret that as him being trying to be very hawkish on inflation, that they will do what is necessary to bring inflation down. It's been above 2% for five years. It's really critical for the Fed to slow lower.

So that was to the market read initially. We saw markets, you know, rates rates move higher right after the meeting. Expectations for Fed hikes got pulled forward to the point where at some point it was the market was actually pricing in a one-fold hike by September of this year.

So just three months for now. As Dustin said a little bit, I think some of that interpretation perhaps was a little too aggressive in terms of what the Fed might actually do. On the committee itself, there are voting members and there are non-voting members.

And particularly the members of the Board of Governors tend to be more influential versus the regional Fed bank presidents. The people who would actually be voting, you know, the expectation is that perhaps they're not quite as hawkish. The meeting there would have been on hold for this year.

We don't know exactly what Kevin Warsh is truly thinking in terms of rate policy because he has clearly said that he doesn't want to provide that kind of guidance. He will be speaking this week at a central bank conference in Portugal. I'm sure questions will come up.

He may provide more color or again, he may give sort of a similar answer. So we won't have any more clarity. In addition to Kevin Warsh, we've had the Treasury Secretary Scott Biffen.

He's also been talking a little bit about monetary policy including a speech last week at the New York Economic Club where in response to a question, suggested that the conditions may be necessary for the Fed to raise rates, which again I guess is sort of interpreted as a tacit approval or tolerance from the Treasury Secretary, the administration, that a Fed rate hike would be okay. Again, that was a few of these hawkish concerns. It's also a different interpretation that what Warsh, Biffen, and others are really focused on is ensuring that the Fed credibility as inflation fighters is maintained, that that's really what they care about more so than actually really hiking rates right now to bring inflation down very quickly.

Now, Fed inflation credibility has not really been in question for the past five years. By and large, inflation expectations and market pricing has been always suggested that the Fed will get back to the 2% target even if that sort of has been continually sort of pushed out. If Warsh and Biffen really did want to get rid of inflation to establish credibility, and the Fed should be probably hiking rates aggressively, one or two hikes, which is what the market's pressing, won't necessarily accomplish that.

So it seems like there might be a little more bark than bite at the moment. Ultimately, the market pricing is one full hike now by October, but one and a half hikes in total by the spring of 2027, then the Fed resumes the cutting. Our view in CIO is that the Fed won't hike at all, and the next move will actually be a cut in the spring of 2027.

Now, the timing of that could shift around, but the overall direction is that the bar is relatively high for a hike, and it's lower for them to ultimately cut. Whether they choose to hike or not, that will probably be determined in the next few months. We will get inflation data for June, July, and we'll have it for August as well before the September meeting, a few more months of data.

The Biffen components of inflation would suggest that perhaps inflation will decline. We know just with oil prices dropping significantly, the headline number will come down. These second-order effects of higher oil prices, higher gas prices, it looks like it's not really materializing.

Tariff inflation feels like it's slowly washing through by the summer. So the result, month-over-month inflation, could actually be significantly lower in the third quarter versus the second quarter. If that plays out, then the case for the Fed to hike will be much lower.

If they don't hike or feel they need to start hiking by September, it seems to me that the inflation story will get better as we move into 2027. So if they don't hike soon, they won't hike at all. A key data point in this whole view is the payroll support that we'll get on Thursday, July 2nd.

If this comes in at or below competitive expectations of $115,000, it would further reduce some of the market's anxiety about the Fed having to hike because the labor market isn't running particularly hot. If we get a job sprint similar to last month, there was a far exceeding expectations around $135,000. Then you'll see the market price hitting probably one full hike and then some before September.

So I think we're not necessarily at a fork in the road, but the next two months, six weeks of data, particularly inflation data, will give a good indication, ultimately, is our view going to be borne out or is the market price actually not aggressive enough yet necessarily for the Fed to hike. If it plays out as we expect, then I think what we see is the market integration moving more towards pricing and the steering we have mapped out for the Fed to cut rather than to hike. So Jason, with that outlook for monetary policy in mind, sticking with the theme of outlooks, we are at the midpoint of 2026.

The U.S. economy continues to perform quite well. So as we look out, Jason, through the balance of the year, what is CIO's outlook for the second half? Well, from a growth and inflation perspective, I already kind of alluded to the inflation story.

The dynamics should get better as we move into year-end. As the different drivers of inflation have been supporting it, higher energy prices, tariffs, even some of the AI-related inflation due to higher chip prices, higher software prices, that should start to peak and roll over as we move into year-end. So that looks relatively benign.

Same time, growth has been quite resilient. The second quarter GDP tracking estimates, a lot of them are around about 2.5%, give or take. But we're seeing good resiliency in terms of consumer spending.

And with oil prices going lower, that will help provide a bit of a boost to the real incomes as we move into the second half of the year. And so some of that could offset a little bit of the surge in spending that we've seen, at least relatively speaking, due to higher tax refunds that help boost spending throughout so far in the second quarter. That's an entail unlikely eases, but it's an offset to some extent if gas prices come down.

So if we do get growth around 2.5% in the second quarter, it is likely to moderate from that level in the second half of the year. So we'd expect closer to around 2% trend. The macro environment, I would categorize it as sort of reflationary, meaning that growth has been surprising to the upside relative to the impact that higher oil prices were expected to have.

Inflation has been going higher. Normal GDP growth will be perhaps around 6% in the second quarter. We're likely to get some moderation in the second half of the year.

Now it really comes down to the pace of moderation, how fast inflation can decline versus how much growth can stay resilient. But in the minimum, we should stay relatively benign macro conditions. And if we move into something that's less inflationary, even if growth moderates, if that helps to ease central bank concerns and Fed concerns about how we can raise rates, ultimately macro conditions still appear to be supportive overall for the finance markets and equities in particular.

So in terms of positioning, Jason, understanding what CIO is recommending for the second half of 2026, as we close out today, can you walk our listeners through CIO's key messages for the second half of the year? Well, one of the key messages and perhaps the most important one is to diversify across equities. It's a message we've been kind of hammering away at for a few months now.

The market performance data that I began with is sort of indicative of that. We've seen, especially in the past six weeks, a broadening out of performance. Some of the prior leaders that are investors are likely still over allocated towards like the MAG7.

They've been actually relative underperformers. But even within some of the other markets that are leading, some of these EI kind of CapEx recipients, they've done very well. A lot of good news is priced in.

What we've seen is a broadening of performance for other sectors, whether it's healthcare, industrials, financials, actually leading the way. Those are three of our sort of attractive sectors. We think that will continue.

We've also seen in other parts of the world getting some sort of tailwinds of Europe in particular as oil prices come lower. That's used off some of the economic strain that Europe would feel from higher energy prices overall. We've seen very strong performance in Asia.

We think ultimately there'll be some bumps in the road, but ultimately we think that will continue to sort of play out. So we're investors who are heavily concentrated in the U.S. and heavily concentrated towards tech and growth stocks. This is not a bad time to be kind of reallocating.

As we go into also the second quarter earnings season, likely to be a very strong earnings season overall. The consensus right now expects 22% earnings growth from a bottom-up consideration. Then it's heavily skewed towards AI infrastructure stocks, so just a handful can account for nearly 50% if not more of that gain.

But the key thing is, again on the consensus view, is that the median stock will have earnings growth of about 9%, which is one of the best sort of broadening out sort of stories we've seen. So again, the macro environment, the earnings environment supports when it continues to broaden out. So that's one key message.

On a similar idea in terms of the commodities, we're recommending investors sort of diversify or broaden out their commodity exposure. As part of the second half outlook, we did downgrade gold from attractive to neutral. Gold began the year and finished last year in a very strong format, but since then has been struggling.

And even recently, just the past couple of weeks, we've seen gold sell off even more. It has been trading to some extent as an interest rate proxy. As rates have gone up, gold has sold off.

It's also been a bit of a de-dollarization trade. There's investors who worry about allocating to the US. But as the AI infrastructure story has played out, the US is a key beneficiary of that.

It's attracted capital, so less interest at the margin recently from diversifying to gold. We've taken out our price target to gold to be $4,600 by year-end and $5,200 in June of 2027. So still significant upside over that time period.

But gold has been very volatile. It's had sort of twice the volatility of equities for the past couple of months. So even though year-end there's decent implied upside to our price target, the sort of risk-reward ratio we think is not particularly strong in the very near term until ultimately the market has become sort of convinced of our view that the Fed won't be hiking and actually cuts back on the table.

If you could see front-end rates going lower, that would provide a boost to gold. But in the overall environment where there is still structural demand for investment infrastructure, investment in AI infrastructure, other commodities, certain metals, we're getting the benefit from that. We think that this is a good time to sort of broaden your commodity exposure away from just gold if that's what you've had in allocation.

Then finally in fixed income, there's two aspects to fixed income from an industry perspective. On the front-end, we think ultimately yields will go lower that the market is pricing in hikes. We think they'll price in cuts.

So locking in sort of yields at the front of the curve, you know, shorter maturity sort of makes sense in these levels. Whereas for longer maturity, we think there'll be a lot of volatility. The 10-year has been sort of, you know, went to the highs over 4.65, fell to 4.4.

We think we'll continue to kind of fluctuate. So you will need to take a lot of industry risk at this point in time. And finally, spreads are very tight.

So again, you're not going to be able to take a lot of credit risk. So we'll be cautious and be selective of where you take it out of this exposure this time. Where that we do like is high-quality munis, even taxable munis, are certainly relative to treasuries.

Well, Jason, following what has been a very eventful first half of the year, very helpful to hear your investment outlook as well as CIO's key messages and investment recommendations as we're now gearing up to head into the second half of 2026. And there will, of course, be a lot to cover over the next six months. So Jason, thank you for dropping by again on this Monday morning.

And I do, as always, look forward to our next conversation next Monday. Thank you, Dan. Have a great week and have a great Fourth of July holiday as you celebrate the 250th anniversary of the U.S.

Be careful with the fireworks. No need to get too close. Have a wonderful break.

You as well, Jason. I will stick to being a spectator only. Looking forward to that.

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

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