UBS Global Wealth Managment (GWM) CIO is advising clients to manage political risk with gold, seek durable income in quality bonds and diversify with hedge funds.
“High levels of implied volatility mean that downside hedging is no longer ‘cheap’ to implement, but the potential range of outcomes is wide and strategies with a degree of capital protection can be an effective way for investors to manage potential downside risks,” noted the CIO in a statement today.
First, the decline in gold prices last week, as some investors sold the metal to meet margin calls, gives an opportunity for investors to gain exposure to an asset that should provide downside protection to portfolios, it said.
Second, US 10-year government bond yields of 4.0% still offer “respectable total return potential and diversification benefits for portfolios”. In a downside (recessionary) scenario the CIO expects US 10-year yields to fall to 2.5%, offering potentially significant capital gains for investors.
Third, hedge fund strategies such as discretionary macro, equity market neutral, select relative-value or multi-strategy can cushion portfolios in down markets.
“We believe that the alpha orientation and conservative posture of multi strategy funds will mean near-term performance is likely to be largely insulated from market volatility,” said the CIO. Similarly, it expects that macro strategies will generate positive outcomes amid the volatility.
The UBS GWM CIO’s base case is that after an initial phase in which tariffs could rise further, US effective tariff rates should start to come down from the third quarter as legal, business, and political pressure mounts, and as deals with individual countries and industries are struck.
“In this scenario, we believe the S&P 500 can recover to 5,800 by year-end,” it said.
However, the CIO warned that investors should prepare for additional near-term downside, because the S&P 500 is not currently pricing much beyond a mild recession.
“We think markets are likely to remain more fearful about how high tariffs might rise than hopeful about how low they might fall,” the CIO said.
On the positive side, longer-term market-implied inflation expectations have dropped sharply, which could help shift the Federal Reserve’s attention toward managing slower growth, which in turn could help reduce the probability of more extreme market downside scenarios.
Hence, the CIO expects the Federal Reserve to cut interest rates by 75-100 basis points to support the economy.
