What's takeaway 1 on Top of the Morning?

May witnessed a strong recovery for indices, though trading has entered a period of consolidation since mid-month.

What's takeaway 2 on Top of the Morning?

The ongoing uncertainty regarding tariffs and trade negotiations continues to be a significant factor influencing market trends.

What are the market implications for Top of the Morning?

Attention should be on the price levels mentioned, particularly if the S&P 500 breaks out of its current narrow range. Monitoring trade discussions closely will be essential, as new developments could catalyze positioning shifts.

What are the risks to this view on Top of the Morning?

Should there be a significant deterioration in trade negotiations or a sudden increase in tariffs, it could reverse current bullish sentiment and impact market expectations drastically. Such catalysts could lead to intensified volatility and a reevaluation of asset pricing.

Top of the Morning: CIO Strategy Snapshot - Waiting for an inflection

What the desk is arguing

The desk posits that while the positive market movement in May suggests potential bullish sentiment, underlying concerns about trade issues and tariff impacts could stifle further upward momentum. Jason Draho's comments indicate that the focus on the outcomes of trade negotiations and tariffs will likely add volatility to market sentiment as we move into June.

Supporting evidence shows that after the tariff reprieve announcement on May 11, market volatility has significantly decreased, evidenced by the S&P 500 trading within a narrow range of 5,800 and 6,000. This type of behavior underlines a hesitance amongst investors as uncertainty around tariffs remains a pivotal factor that could shape future market outcomes.

Where it sits in our coverage

Currently, we target a consensus of 1.075, with a range from 1.04 to 1.12.

Given this context, our outlook is consistent with jpmorgan at 1.10 for March 2026, while diverging from bofa which projects a more cautious target of 1.04 within the same timeframe. We sit near the upper end of the forecast range, suggesting a more optimistic leaning compared to the broader market consensus.

How other firms see it

In this environment, firms like jpmorgan and others remain optimistic about a potential upside, whereas bofa counters with a perspective aligned towards caution. This delineation in views underscores a bifurcation in sentiment where some are betting on a revival of market confidence driven by favorable trade outcomes.

Key related elements to watch include the USD/JPY currency pair, which often reflects the investor sentiment influenced by ongoing U.S.-China trade negotiations and the Fed's monetary policy stance. Market fluctuations here could serve as a barometer for broader market performance amid the lingering uncertainties.

Hi everyone, Siobhan Chapman here and welcome to Top of the Morning on the UBS Market Moves podcast channel. May was a good month for the markets, but there are many questions that advisors are asking as we enter June, such as the fate of tariffs, the outcome of trade negotiations, the status of the one big beautiful bill, and what impact the tariffs will have on the economy. To discuss these and other questions and what they mean for the market outlook is Jason Draho, head of Asset Allocation Americas.

Jason, let's get started. Let's begin with the markets. How do you assess recent performance?

Well, it was a good month in May of the S&P 500 was up 6.15% after a very tumultuous April. And now it's in the positive territory of the year, marginally so, but at 0.5%. So it's almost as if we kind of reset the start of the year, like being flat as we head into the summer.

But the good month for May is a little bit, I wouldn't say misleading, but there's nuance to the story. The bulk of that performance happened in the first 12 days. There was the announcement back on May 11th of a U.S.-China sort of tariff reprieve, where the tariff rates would come lower on the following Monday, the 12th.

The markets relied strongly on that news. Since that day, the markets across different asset classes have been relatively calm, trading in sort of relatively narrow ranges. And to give you some perspective, the S&P 500 has been between 5,800 and 6,000 during that time period, the last three weeks.

Last Friday, the last day of May, it was down 0.01%, so effectively unchanged that day. That was the fourth day in the past three weeks in which the absolute return for the S&P 500 was less than 0.1%, or 1.1% or smaller. So very small changes on four of those days.

Prior to May 12th, for the entire calendar year of a little over almost four and a half months, there's only six such days. So again, a six suggests the markets are moving relatively small amounts. That's reflected in BIX, which has been mostly between 18 and 20, so coming down to more kind of reasonable levels.

This is also evident in other asset classes, the 10-year treasury yield has been between like 4.4% and 4.6%, the two-year yield between 3.9% and 4.05%. Market pricing for the number of Fed rate cuts this year by December has been pretty closely stayed around two cuts this year. The dollar sort of fluctuated in a relatively narrow range.

So overall, kind of relative calm as the market sort of digested sort of these tariff kind of reprieves. And so I think that is kind of how we enter March or how we enter June. You know, good recent performance, but sort of indicative of investors kind of assessing, you know, what's coming next at this point in time as the market's been in relatively narrow ranges in recent weeks.

So, Jason, moving on to tariffs. The Court of International Trade struck down the IEPA-imposed tariffs, but the Court of Appeals granted a temporary stay, allowing them to remain in place. Giving that, what do you expect will happen with tariffs and what does this mean for trade negotiations?

Well, it certainly throws a bit of a curveball into the whole tariff developments. You know, the markets have been assuming after that U.S. China tariff reprieve deal with the U.K. that we are inching towards more deals and more sort of confidence that the tariff rates would not rise significantly.

This kind of throws a little bit of uncertainty into it. And since then, we've also seen a bit of re-escalation of the U.S.-China trade tensions with the current administration, the Trump administration, looking to increase more restrictions on technology accessible to Chinese companies. And then also on Friday, President Trump announced a 50 percent tariff on steel and aluminum imports as effective as of June 4th.

So it's a kind of reminder that this tariff story is certainly not over by any stretch. But given a lot of all this sort of noise, I guess, you know, where do we kind of come out of it? Ultimately, I'd say that the end point for tariffs is only going to be that much different than it was.

We could go before these developments, but the path to getting there is going to be a little bit different and potentially more elongated, therefore adding uncertainty of how this will all play out. Now, when I say it's an end point for tariffs, what I really mean is the effective tariff rate that would be applied to goods. And this is just simply you take the amount that's imported in the U.S., the amount of customs duty that has to be paid for those imports, take that as a percentage, you know, we think of that as the effective tariff rate.

And it's somewhere in the mid-teens, around, you know, 13, 15 percent of sort of what we're assuming, whereas 10 percent or lower would be a bull case and 20 percent or thereabouts or higher would be kind of a bear case kind of outcome. The Court of International Trade struck down tariffs that were imposed using IEPA, which is sort of an Emergency Act provision. Their claim would be that, well, there wasn't clearly an emergency that justifies tariffs on all countries, on those fentanyl tariffs that were applied to Canada, Mexico and China back in the winter.

So that's the ruling. This could ultimately kind of go to the Supreme Court. That will take some time to decide.

There are other means of legal measures the administration can use to impose tariffs, but that kind of biases towards more sector specific tariffs. You can't impose tariffs if there's an investigation that's proven as being harmed on to U.S. sectors, unfair competitive advantages imposed by the countries. And that's likely what the administration will do.

So perhaps less or a little bit lower broad based tariffs across the board, but higher tariffs on specific assets or specific goods. The end result in terms of the effective tariff rate again should still be in the mid-teens range. At least that's kind of what we'd be assuming.

But this will take kind of more time because sector specific tariffs require investigations that can take at least a few months, not longer. So that sort of pushes us further into summer. It could also mean that you have what the core challenge is, uncertainty of when things would sort of be resolved to give the administration guidance, what path they're more likely to want to take.

And then for other countries looking at all this, this does perhaps create an incentive for them to want to not negotiate, to see how the court system plays out, to see what the sector specific investigation is going to deal with. So I think there's probably some bias towards not wanting to offer sort of concessions at this point, just because they don't know what's going to come out. But it's also clear that at different points of time, President Trump is willing to offer reprieves because of what you're avoiding potentially the cost to the financial markets or the economy of higher tariffs.

So again, a reason for negotiations to take a little bit longer. So I think really what it means is, well, the court ruling is an incremental sort of positive direction in terms of the level of tariffs that could ultimately be imposed. The net result is perhaps more uncertainty than investors were assuming just from a few weeks ago.

More time for this all to be resolved. The end result is probably similar to where we were before. Turning to the economy, activity seems to be holding up while sentiment has improved.

What is your read on the economic outlook? Well, it was the case in April that sentiment was deterred quite rapidly for investors, but also consumers responding to the higher tariffs, the potential increase in cost, the negative impact to the economy. The actual economic data was holding up relatively well, in part because in the anticipation of tariffs, there was kind of front running by consumers to buy goods before the prices potentially go up.

Likewise, with companies importing goods before the tariffs would be in place. So the data we've gotten thus far shows a decent amount of resiliency and actual kind of hard economic activity, including sort of labor market activity overall. It was a soft sentiment that was relatively weak.

What we see now, because of these tariffs, the soft sentiment is starting to improve from a low level, but it's sort of converging back towards at least a little towards the hard data as consumers become a little bit more optimistic. What we have seen thus far, though, in the data is kind of a little bit hard to interpret. It's relatively noisy.

We did get a revision for Q1 GDP numbers last week, slightly better than expected, instead of minus 0.03 percent, it was minus 0.2 percent. But then we look at what is the tracking estimate for the second quarter GDP, the Atlanta Fed tracking estimate, which is widely followed, is now up to 3.8 percent. So this is clear.

Q1 is not as bad as that first number appeared. Q2 is not going to be as strong as the tracking estimates indicates because it's being distorted by imports that are net imports and net exports that are swinging wildly in response to these tariffs. A better indication is kind of real domestic final sales.

That was 2 percent in Q1. It's likely going to be a lot less than that, maybe only 1 percent in Q2. So certainly weighing on consumer spending.

But we need more data to assess that. We get a lot of data this week from the payroll report on Friday to the ISM manufacturing surveys, Joel's data, other labor market data that will give a better indication of the status of the economy. But our expectation is, I think the market expectation is that the tariff impact will still be not fully evident for at least a couple of more months.

First, you need to see companies raising their prices, passing along those price increases that may be evident in May, but more likely to start to appear in June and July. As those go up, it does impact kind of real income spending power declines. That's going to affect consumer spending.

That will affect the labor market. So this is still to become in terms of the consequence of the data. But the story right now has been a relatively resilient economy.

And so not yet signs of the tariffs having a major impact. But that's more likely to kind of come down the pipeline. But it does mean, given that we haven't yet seen that rollover in the data, it's probably also one of the reasons why the financial markets have been able to hold relatively steady.

And it's really risk assets to be able to kind of bounce back because we haven't seen yet clear weaknesses. What do these policies and economic developments mean for the market outlook? Well, I go back to my comments about the markets for the past few weeks been in a relatively tight kind of trading range.

You know, the way I sort of interpret this is that investors are kind of standing pat. They're waiting for news to see a clear inflection point in the outlook, either positively or negatively. Things are going to be better than expected because there's trade deals or worse because they're not going to be in place and the economic conditions are kind of rolling over.

I think we need to see some kind of news, sort of new news for the markets to kind of break out of these ranges. An overall aggregate assessment of investor positioning data through a number of different metrics would suggest that it's somewhat neutral after being relatively pessimistic and more cautious after Liberation Day and certainly more risk on sort of positive risk positioning back early in the start of the year. Relatively neutral, again, consistent with investors not quite sure yet exactly what the direction of travel is for the economic news, for the policy news and therefore the markets overall.

I think relative to what's pricing across asset classes, which I'd say is priced for kind of slower growth, but certainly not a recession. I think the risks are probably skewed a little more toward the negative inflection points. And in terms just because there's still a lot of uncertainty in terms of what could happen with trade deals, tariffs.

We haven't seen yet the economic data really been impacted. That certainly could materialize. And then the one big, beautiful bill, I think the markets have looked at the recent developments and thinking that could be equally positive for the growth outlook for next year relative to earlier expectations.

Whether that still holds out or whether that leads to higher rates or not, that is certainly something that can weigh on the markets to some extent. But I really want to emphasize that we need to see sort of new news to break out of these recent ranges. You know, the so-called sort of taco trade that has been, you know, we've been talked about in the markets, but also the broader public of which is short for Trump always said chickens out, meaning on tariffs that he announced would be tariffs, a sign of weakness.

He walks them back. He's certainly, you know, Trump pushed back on that when asked by a reporter last week. But the idea that investors are kind of skeptical that high levels of tariffs will stay in place because of the economic pain, I think that's going to be the view of investors until they really see some sustained fall through and real impact on the economy.

Otherwise, any announcement of higher tariffs or different trade issues, I think the markets will kind of shrug their shoulders a little bit. We have seen we've seen this story before until we see the negative implications. We're not going to react.

Another story dominating the markets throughout May was the rise in rates, especially at the long end of the curve at the 30 year point going higher. But to really kind of break out of the range in the 10 year in particular, you know, to break out of the range of 4.4, 4.6 percent and on the upside going higher, we need to see growth and or inflation data really surprising to the upside in significant ways or something on the fiscal front where the difference will be even bigger as a result of what passes through the Senate ultimately kind of becomes a law. Otherwise, a lot of this information like large deficits going forward, you're relatively maybe higher inflation because of of the tariffs.

This is sort of no, this is priced in. So we need something more to kind of move the market significantly higher for rates to go significantly higher. And unless that doesn't happen, then again, that removes a potential headwind for for risk assets, at least in the near term.

So for when we think about is summer is essentially here, it's likely we'll see some inflection points instead of shifting narratives in the marketplace that could break us out of these ranges. What happens and how it plays out really kind of depends on the sequencing of when different types of news come forward. So don't be surprised if we see some one or two sort of pivots in the market in terms of what is the narrative that happened last summer where early July of twenty twenty four things look kind of relatively golden locks.

Then the market's worried about growth. We saw significant sell off after week July jobs report. The things bounce back relatively quickly.

We could see something along those lines this summer as well. I think the most important thing is that on a medium term horizon, ultimately some of these short term inflections and news flows don't really matter. It's more about what is the fundamental story for for the next 12 months.

And there were a little bit more constructive in terms of how the tariff story would play out. What does it mean for the economy? Slowdown, not a recession and ultimately macro conditions that are generally supportive for risk assets on a 12 month horizon.

So we are coming to the end of our conversation, Jason. Based on all of this, what should investors be doing? Well, I'll pick up on my last comment about sort of more constructive on a medium term 12 month horizon.

You know, what a key message we have right now sort of to phase into equities to be fully invested, but to be looking at exposure on sort of decent pullbacks, probably something below that fifty eight hundred range, because at that point in time, we still think there's there's decent upside. And if you go up to fifty eight hundred with a price target that we have for the S&P of sixty four hundred for next June, that would imply more than a 10 percent kind of total return. So those would be levels that would become opportunistic to phase into equities in terms of what we like within equities.

Tech still remains an attractive sector. We've seen in the past month, a couple of months that they make seven and some of the banks have bounced back reasonably well, including NVIDIA. And this is reflective of the belief that we have that's been unable to remain largely intact.

And tech specifically also has a kind of high quality bias. It should hold up better even if the economy a little bit slows. And these sort of secular trends are also evident for the communication services sector, which is dominated by Meta or Facebook and Alphabet, Google through both their investment and benefits from from AI, but also digital advertising trends as a bit of a hedge.

Utilities is a sector that we like. It's defensive. And if the economy does slow, there's potential for upside, especially because there's strong AI power demand.

If we look outside of the US, a couple of things we like are the China tech sector for those who are kind of want to play the AI team a little bit more globally. And then there's a lot of ways in Europe to kind of be positioned aside from having exposure to the tariff situation overall within fixed income. Well, rates could stay sort of somewhat range bound.

The risk certainly is for longer than the curve for rates to kind of go higher. We don't think you're at this point time. It's kind of worth taking that risk.

So we continue to sort of recommend more maturities up to about the five year maturity category point. It's been up in quality. Now, I need to take a lot of risk because as the markets come back again, spreads have tightened again and not offering a lot of competition for taking risk overall.

So higher quality fixed income like mortgage backed securities, treasuries, high quality investment, great bonds. And finally, gold has been a good portfolio hedge. It's topped around recently, but it's even up on Monday morning.

So, again, it's a diversified portfolio. So there's a lot of uncertainty. It's been a relatively effective hedge and we think that will continue going forward.

So definitely a few things for investors to kind of think about a position for as we go into the summer. Markets are relatively calm at the moment, but that is unlikely to last throughout the entire summer. Something, whether it's trade related, fiscal policy related, economic data surprises that will move the markets positively or negatively one way or another.

And it's more likely, you think, to pop negative before it becomes positive again. OK, perfect, Jason. Thank you so much for joining us.

You're welcome. Have a great week, Sean. Thank you for tuning in.

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