Macro Monthly

Economic insights and asset class views

UBS Asset Management | September 2024

For global professional / qualified / institutional clients
and investors and US individual investors.
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A critical window

Highlights
– The US economy is entering a critical window over the next few months, in which the
labor market must hold up before the effects of rate cuts and broader easing of
financial conditions can provide a cushion for growth.
– We believe that healthy initial economic conditions will bridge growth through this
phase, but already optimistic market pricing and the potential for a near-term growth
step down warrants dialing back risk tactically.
– This more cautious stance lines up with historical seasonality of equities before
Evan Brown presidential elections, as markets tend to wobble amid policy uncertainty in the weeks
Head of Multi-Asset Strategy
ahead of voting.
Active Multi-Asset
– With less overall beta risk, we prefer to focus on relative value opportunities, favoring a
broad set of US stocks vs. ex-US equities, and short positioning in Japanese government
Meena Bassily bonds and USD/JPY.
Director
Active Multi-Asset It was a memorable August for investors. At the turn of the month, a disappointing jobs
report and Bank of Japan tightening kicked off a sharp unwind in popular positions. The
VIX spiked to its highest levels since the onset of COVID-19 in 2020, Japanese equities
dropped 20% in three days, and the US two-year yield crumbled nearly 40 basis points in
short order. At the time, we argued the volatility was more driven by technical than
fundamental factors, specifically the unwinding of stretched and leveraged positions amid
summer illiquidity.

Since then, the MSCI All Country World Index has more than recouped its losses and set
all-time highs, much faster than we anticipated. A string of favorable economic and policy
developments catalyzed the rebound. First, while the US employment report for July was
disappointing, other labor-related data did not corroborate the weakness suggested by
that report. Second, strong retail sales and earnings reports eased concerns about an
imminent recession. Lastly, a third consecutive downside surprise in monthly headline
inflation allowed Federal Reserve Chair Powell to shift more focus to labor market risks,
delivering an unequivocally dovish message at Jackson Hole.

Now what?

While recent developments have undoubtedly been positive, we see the risk-reward for
global equities as less favorable at current valuations. A lot of optimism has been priced in,
and there is little margin of safety at current valuations in case economic growth
deteriorates faster and by more than expected. We are entering a critical window in which
investors will have to judge whether easier monetary policy is arriving soon enough to
cushion a clearly slowing labor market. Historically, equity performance one-to-two months
before a US Presidential election has been poor (on average). Accordingly, we have
downgraded equities from overweight to neutral and prefer to focus on relative value
opportunities across asset classes.
A less attractive risk-reward
Exhibit 2: Lending standards have tightened by less
The bull case for equities has been straight forward. The 100
economy is holding up, and central banks are set to cut rates. Tightening standards for
80 loans
The challenge now is that this optimism for the outlook looks
more than priced. The forward P/E ratio of MSCI World is well 60
above its historical average at near 18x vs. a 30-year average of 40
15x. Forward earnings expectations still indicate double digit 20
percentage gains at a time when nominal GDP is set to 0
downshift even in a soft landing. And the rates market has now
-20
priced in 100bp of Fed cuts to year-end, with terminal rate
pricing at a cycle-low of 3%, as indicated by the two year/one -40
year overnight index swap (OIS). Risk assets are unlikely to get 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 24
further support from lower yields, as further declines will most Commercial loans: Large firms
likely reflect rising concerns on economic growth. Small firms
Commercial real estate
A critical window Source: Bloomberg, Federal Reserve, UBS Asset Management. As of August 2024
The cooling of the labor market has been gentle so far, with a
slower pace of job growth and rise in the unemployment rate. Moreover, initial conditions matter, and they portray an
But as long as job growth is persistently slowing, there is the risk economic backdrop that is much healthier than before prior
of hitting a breaking point, where layoffs spike and a negative easing cycles that preceded recessions. We see no obvious
feedback loop kicks in between employment and consumption. structural imbalances in the economy and think private sector
Labor market internals show that cyclical and interest rate- balance sheets are healthy in aggregate, with debt service ratios
sensitive sectors of the US economy, like housing and at historically low levels. Corporate margins and consumption
manufacturing, have started to weaken. Cyclical employment growth typically slow before a recession; they have been
can lead both initial jobless claims and the unemployment rate. improving.

Fortunately, Fed Chair Powell left little doubt that rate cuts are We are entering a critical window through to the end of the
on the way and the Federal Open Market Committee is year, where the labor market and broader economy will have to
prepared to act aggressively to ensure the labor market ‘hang in’ before the effects of lower interest rates can take
stabilizes. The question is whether recessionary dynamics have hold. The market is likely to be highly sensitive to labor market
already kicked into gear and it is now too little, too late from indicators and signs that interest-rate sensitive sectors like
the central bank. In fact the Sahm rule, a widely tracked housing and manufacturing are gaining some traction from
recession indicator, has been triggered. lower rates. It would not take much, given the optimism priced
in, for the market to experience a ‘growth scare’ in coming
months. Thus, even though we are optimistic there will be an
Exhibit 1: The rise in US unemployment has triggered the ultimate soft landing, it makes sense to take a few chips off the
Sahm rule table in the near term.
8.0
Oh, and there’s an election
7.0 Of course, this critical window for the economy coincides with a
critical window in US politics. With just over two months until
6.0
the US election, current polling and prediction markets suggest
a very close race. Historically, markets correct in the one-to-two
5.0
months leading up to the election, and then rally after it
4.0
regardless of whether a Republican or Democrat is elected. This
likely reflects discomfort with policy uncertainty and then
3.0 ultimately relief from policy clarity.
16 17 18 19 20 21 22 23 24
US unemployment rate 3 month moving average And there is plenty of policy uncertainty for investors to stew on
Sahm rule trigger within both parties’ platforms. Vice President Harris’s plans to
Source: Bloomberg, Bureau of Labor Statistics, UBS Asset Management. As of
hike taxes on corporations and high earners, including
August 2024 significant changes to taxation of capital gains, creates clear
risks to equity markets, for the US in particular. Meanwhile,
Our base case is that it is not too late to avoid recessionary former President Trump’s market friendly proposals to extend
dynamics. Broad financial conditions have eased over the course tax cuts and deregulate must be weighed against further deficit
of the year, well ahead of the actual rate cuts – these should expansion and stagflationary policies on immigration and tariffs,
support growth albeit with a lag. Lending standards for the latter of which is a particular concern to markets outside the
commercial and domestic loans have actually tightened by less US.
for several quarters.

Page 2 of 6
 Similarly, within FX, we favor the Japanese yen over most
Exhibit 3: S&P Seasonality on election vs. non-election
currencies on relative policy dynamics. We also think the
years Japanese yen would offer protective properties should the more
110 negative economic scenarios outlined above materialize. We are
S&P 500 Seasonality (1976-2024)
108 neutral on the US dollar more broadly, with the index caught
between dovish Fed policy and the relative outperformance of
106
the US economy and assets. We would turn bearish on the USD
104 on more evidence of a soft-landing scenario accompanied by
aggressive Fed cuts.
102
100
98
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Presidential Election Year Average

Non-Election Year Average
Source: Bloomberg, UBS Asset Management. As of August 2024

Post-election, it is likely that actual policy outcomes turn out

better than feared. Vice President Harris would require both
houses of Congress to enact her tax policies, and the Senate
map is difficult for the Democrats. A 50-50 split in the Senate is
likely the best they can hope for, with a Vice President Walz
being a tie-breaker. Such a narrow majority will make it difficult
to enact controversial tax changes. Moderate Democrats stood
in the way of major tax hikes even when Democrats held a
Senate majority in the first two years of President Biden’s term.

And while the sheer scale of former President Trump’s tariff

threats (60% on imports from China and 10% on imports from
all other countries) would be quite damaging domestically and
internationally if carried out in full, we suspect much of these
would be used as negotiating leverage and ultimately be
watered down.

Asset allocation: Focused on relative value

While we are cautious on the overall direction of equities in the
near term, we see opportunities in relative value. Within
equities, we favor the US over the rest of the world due to its
stronger earnings profile and comparatively lower exposure to
the weakening manufacturing sector. While this may seem
counterintuitive given the aforementioned risks to the US
economy, we note that historically US equities tend to
outperform during slowdowns, even when the slowdown
originates domestically. We focus our US exposure on a broad
range of stocks so that it is not overly concentrated in the AI
theme.

In fixed income, we are neutral duration and credit. For the

former, the market has already priced in a great deal of easing
for a soft landing scenario, so exposure to sovereign bonds
serves largely as a hedge for risky assets. In credit, spreads are
pricing in little default risk in an economic slowdown, but
attractive all-in yields keep us neutral.

As with equities, we prefer a relative value approach. We are

short Japanese government bonds vs. the US and UK as we
believe the market is significantly underpricing further
tightening from the Bank of Japan. Rates pricing remains far
below even the lowest estimates of Japan’s neutral rate, all
while Japan’s wage growth and consumption point to a
structurally higher nominal GDP backdrop than we have seen in
decades.

Page 3 of 6
Asset class views
The chart below shows the views of our Asset Allocation team on overall asset class attractiveness as of 29 August 2024. The
colored circles provide our overall signal for global equities, rates, and credit. The rest of the ratings pertain to the relative
attractiveness of certain regions within the asset classes of equities, bonds, credit and currencies. Because the Asset Class Views
table does not include all asset classes, the net overall signal may be somewhat negative or positive.

Underweight Overweight

    
Global Equities  Downgraded to neutral as risk-reward less positive as economy, earnings slowing
amid high valuations.

US  Relatively strong earnings profile and less manufacturing sensitive than global
equities. Prefer equal weighted index to AI-concentrated S&P 500.

Europe  Disappointing economic and earnings data. Ongoing challenges in global

manufacturing is a weight.

Japan  Ongoing corporate reform, solid earnings countered by renewed JPY strength.

Emerging Markets  Skeptical EM can outperform ahead of US election especially with continued China
growth malaise.

Global Government Bonds  Disinflation has brought stock-bond correlation negative again, but there is a lot of
easing priced.

US Treasuries  Gradual growth and inflation moderation improves hedging properties. Prefer US to
Swiss/Japan bonds.

Bunds  ECB to ease policy further amidst cooling inflation, middling growth. But well priced
into rates market.

Gilts  Expect wages and service sector inflation to slow; gilts are attractively valued.

The risk-reward outlook for credit is not particularly attractive, especially in the US,
Global Credit  where spreads are close to cycle tights. EUR and Asia HY still offer the best carry
opportunities.

Investment Grade Credit  Spreads are around usual cycle tights, while corporate fundamentals remain
relatively healthy. Returns likely driven by carry.
Further price upside is limited with spreads around 3% and the return outlook is
High Yield Credit  negatively skewed. But all-in yields remain attractive in parts of the market. Prefer
EUR HY over US.

EMD Hard Currency  Few pockets of value remain among very weak EM creditors, while higher-rated
countries are trading at historically tight spreads by now.

FX

USD  Shifted from overweight to neutral amid clear evidence of slowing US inflation and
growth.

EUR  Upgraded to neutral as services inflation remains sticky relative to the US.

JPY  BoJ intent on tightening much more than priced as long as global economy holds
up.

EM FX  Bumpier environment for EMFX carry as volatility rises.

Global growth gradually slowing and OPEC+ likely dialing back production cuts in
Commodities  the quarters ahead should keep Brent well below USD 90. Gold is structurally
supported but has priced in a lot lately.

Source: UBS Asset Management Investment Solutions Macro Asset Allocation Strategy team as of 29 August 2024. Views are provided on the basis of a 3-12 month
investment horizon, are not necessarily reflective of actual portfolio positioning and are subject to change.

Page 4 of 6
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