Top of the Morning: CIO Strategy Snapshot - Investing in a fast-changing world

Hi everyone, Dan Cassidy here. Welcome back to top of the morning on the UBS Market

Moves Podcast channel. We are coming to the end of April with summer just around the

corner. Equity markets have already begun heating up this spring and Q1 earning season

reaches a peak this week with about 40% of the S&P 500 reporting. The Federal Reserve's

FOMC meeting is also on Wednesday, which is likely to be Jay Powell's last as Fed Chairman.

So joining us to discuss this all on this Monday morning, glad to once again welcome back

Jason Dreho, the head of asset allocation for the Americas. From the UBS Chief Investment

Office, Jason great to be back at the table with you on this Monday morning. Thank you

for dropping by.

Good morning, Dan. Good to be here. Happy Monday.

So Jason, for the first time in two months, I did not mention the U.S. around war as part

of the lead-in. Despite that, of course, does remain a factor which merits monitoring.

What is the latest CIO view on the conflict and what does it mean for the markets at this

point?

It is sort of noteworthy where I think almost exactly the two-month anniversary when this

began. I don't want to make a lot of the situation. It's still obviously ongoing, but I think

from a market's perspective, we've reached a point where you kind of have the ceasefire

that's sort of holding, you know, but not a clear ceasefire. Also, just thinking about

last week on, again, off-again negotiations, like reports that, for example, J.D. Vance

is on a plane to Islamabad and he's not on a plane back and forth. So I think the markets

are a little bit exasperated by it, but also we just don't know what we seem to have as

a bit of a stalemate. It seemed to be past the peak on certainty. Now, the real question

is, like, when does the straight kind of open up sufficiently that oil can start flowing

through because that's not been the case this far? So if you think about the market performance,

given that we're just not getting really new information from, you know, from the Middle

East, investors have kind of moved beyond the war, you know, and kind of ceasefire discussions

as a primary market driver. And you can see market pricing is somewhat desensitized to

what it was, you know, to the price of oil. And you could just see, you know, how much as

price of oil goes higher, how much you've seen bond markets, equity markets respond. Still

negative, but, you know, that the, you know, rate of change has become much smaller. What

we have is the markets are much more focused on kind of the AI narrative ones, again, kind

of going back to where we were, you know, two months ago in February, you know, reports

of, you know, cap expending in last week, you know, with one company Intel reported very

good numbers, causers talk place to go up, you know, 20 plus percent. And so that's, that's

kind of where the, you know, what's the key things as earnings will get into, you know,

the macro economic data, from the conflict itself, you know, like, again, you know, the

way the market's ultimately kind of basis on is when will we get a, at least in opening

the straight to whether there's ceasefire, not ceasefire, like, you know, how long that

plays out, that's almost to get from the market's perspective. So the secondary can there be

something that would open up the straight that will allow oil and other goods to ship through.

The latest reports overnight is perhaps the Iranians were a floating idea that we can do

something on the street, even if we don't necessarily negotiated clear deals on, you know,

nuclear disarmament. So for us, you know, what we are assuming then is the straight will

kind of gradually open up enough, such that ultimately, what is the price of oil going

forward? You know, but again, two months ago, the futures market was pricing, you know,

Brent crude to be, you know, less than 20 dollars a barrel through out to 2026. Now in our

base cases that we're going to assume that oil is going to be a hundred dollars a barrel in June,

and we're a little bit over that now, but then 95 by September, 90 by December. So kind of a,

you know, kind of peaked out around now, but it pretty gradual to set for the rest of the end.

And that's going to be a bit of a drag on growth. We can be wrong about that. Things could escalate.

This could take, you know, much, much longer for the straight to open up or at least supplies to

move forward and out that prices can go lower. That is the risk, you know, but right now,

the markets are assuming something along those lines and that this won't further escalate.

And therefore, we go back to more of the economic and AI fundamentals driving the markets.

Moving along, I did mention that the FOMC is meeting this week. We will receive the outcome

on Wednesday. In addition to that, it does appear this point that Kevin Worsh will get confirmed

by the US Senate over the next few weeks. What is your expectation for the Fed this week and

under Kevin Worsh? Well, just for this week, don't expect very much. They're not going to

hike or cut, and that's almost, you know, carved in stone. The communication changes are somewhat

limited because they'll update their statement, but there's no change in economic projections.

There's no change in the dot plot. So it's likely the message this time end of April will be

similar to what it was in mid-March that they're going to have very much as sort of a wait and see

mode. They would fill policy as sort of in a decent place right now because the risks are somewhat

too sided. Inflation could, you know, stay elevated. You go even higher if this conflict, you know,

persists at the same time if it does persist and all prices go higher. That will be a negative

for the economy. The risk is then the downside to growth and the labor market. So they kind of

have to balance it out for the time being kind of comfortable, you know, sitting where they are.

So a lot of the focus then will be, you know, where do we go from here? On Kevin Worsh,

the key, a couple of key things. One is that the Department of Justice sort of dropped his

investigation into FHRJ power grouting, sort of the renovations and construction of the FED,

you know, building in DC, pertaining to testimony before Congress. That's what the legal situation is.

That case has been dropped. That was a sticking point for Senator Tom Tiles from North Carolina,

who sits on the Senate Banking Committee, who said I will not, you know, vote to approve anyone

for the FED chair, as long as this investigation is out there. Without his vote, there would

be enough votes for anyone to kind of pass through the Senate Banking Committee, which is a necessary

prerequisite to go to the Senate floor to approve someone. Given the DOJ dropped its investigation

on Friday on Sunday morning, I think on one of the talk shows, Tiles said now he was willing to

vote for Worsh. So assuming the committee will vote the next week or two, it goes to the Senate floor,

it's likely to vote, you know, by, you know, me 15th, that's when Powell's run as chair would expire.

Some of the mechanics of a voting, you know, at Senate, Senator's and Officer not like that could

you disrupt a little bit, but very, very likely, if not by, you know, me 15th by the end of May,

enough so that Worsh is in the role by the mid-June when the next OFMC meeting it takes place.

So then real question becomes like, what does a Fed chair under Worsh look like? How does monetary

policy change if at all? You know, we are in an environment where inflation is elevated,

it could go even higher, at least in the new term before we go in lower. I think it would be hard

to get your first meeting at committee kind of wrapped around the idea of actually cutting rates,

and it is a committee. It isn't the chair has unilateral decision, can use moral

and arguments to try and sway the committee members, but if enough people are apprehensive,

it'd be difficult to Worsh to get enough votes, and it would be look bad in his first meeting to

try and push forward and vote for a cut, and the rest of the committee majority isn't vote for it.

What we can look at is, you know, kind of views of Worsh based on his testimony last week.

Right. Similar to what he said before, you know, folks a lot on the balance sheet wants to

shrink the balance sheet. That is, that is nothing new. Use more interest rates policy to kind of

set Fed policy. You talked about the communication and sort of the idea that Fed preps over

communicates, and as a result, you know, the message and the guidance from the Fed is, you know,

is not too clear, so there could be some change in Fed communication going forward, although

it's part of its every five year that Fed does review its policy. One of them was their

communication strategy, and what Paul said at a press conference when asked about this earlier

in the year was they could not agree on like how to change the communication. So the idea that

there'll be a massive change in that that's kind of unlikely. I think the one notable thing that

Worsh had mentioned during his testimony was the inflation metrics they think they should focus on,

looking at trimmed, trimmed mean inflation measures or median. So trim mean the ideas that you take

off like the most extreme, you know, say 10% of the top or the bottom, that could be, you know,

kind of skewing things hard because they're so elevated. Same thing with the median, kind of the idea

is you kind of get rid of the extreme outliers that can distort the overall average.

Which you could, you know, that's a data point one can look at, you know, if you look at it right now,

I think the Dallas Fed, the Cleveland Fed have their own measures of sort of trimmed mean inflation.

It is running like a 2.5%, 2.3% versus core PCE, which is what the Fed relies on, that's like 2.9.

So one can look at that and say, well, if you want to make an argument that you should be cutting

in rates, you can point to the inflation data that is on the low end of the spectrum.

In independent weather, it gets actually better to look at that and you can have an

intellectual argument, it just, it's, it's such that right now it actually favors cuts.

So that could be an indication that Worsh is going to try and emphasize inflation is not so bad

that we should be moving towards cuts. Now ultimately our base case, you know, for a couple of

months and we knew Worsh would be, was the nominee, was that the Fed would cut in September and

December 25 basis points each 52 total this year, you know, whether that ultimately gets pushed

back a little bit, I think that's, that's possible. But from the overall market perspective,

that doesn't really make much difference. The point is that you have a Fed that is by still towards

easy, not hiking rates, that's very unlikely. And you have a Fed chair that seems to be more

on the double chin of the spectrum. How much it could also further change will be depend on whether

J. Powell decides to resign from the Board of Governors on which we give President Trump a chance

to appoint someone else, presumably someone who's on a more dovish end of the spectrum.

They're still not standing case only so cook, whether she could stay on the board or not. If she's

removed again, you could have a more clear shift towards the dovish committee members, all of which

aside from the macro conditions, you know, the, the competition the Fed would suggest that cuts are

much, much more likely than, than hikes at this point in time. Let's move along to the Q1 reporting

season, as mentioned, a busy week ahead of us with 40% or so of the S&P 500 reporting.

Jason, curious to hear about your reflections on the results we've seen thus far?

We've had about 25% of the S&P 500 market cap report. We look at both how much companies are

beating their sales or revenue, but also how much they are beating their EPS estimates.

And it's just shy of 80 companies are beating, you know, sales and EPS. So good sort of results

above historical averages in terms of beating earnings, which tends to be around 70% and

being, you know, sales, which could be around like 60%. So good on that regard.

It's also the magnitude of earnings beats is also ticked up, you know, and with the

meeting company now beating by about 5%, so a healthy beat there. So the overall story,

the data we have thus far very much consistent with our CIO's expectation of 17% earnings growth

in Q1, if anything, that's likely to be understated. We do get 40% of the S&P 500 market cap

reporting this week, including five of the hyperscalers, which includes, and hyperscalers,

these are the companies investing enormous amounts of money on new data center bill odds.

This includes alphabet, Google, Facebook slash meta, Apple, Microsoft and Amazon.

They've continually sort of ramped up how much money they're spending on,

on, you know, CapEx. If they kind of again sort of ramp up those numbers, you know,

on the context of Q1, I think Facebook basically doubled their amount of investment for this year. So

if we see that, that could, you know, again, sort of be a boost, you know, for overall expectations

in the market. Those companies may or may not be as rewarding, because what we've seen for the

past few months and past recorders is that the market isn't necessarily rewarding the CapEx

spend of the hyperscalers, but it clearly has knock on benefits for the whole AI value chain.

And we've seen that with other semiconductor companies, your companies that are involved in

building out the data centers, providing energy. So it's kind of a whole ecosystem.

And so if those companies continue to spend, there's going to be beneficiaries elsewhere that

would show up in earnings of other companies down the line. So I think it'll be, you know, if they

don't sort of kind of, you know, be and raise to some extent, I mean, yeah, the market could be

a little bit disappointed if they do, and they're going to do what they've done in the past,

where the numbers go up higher. That would be a further catalyst for the overall earnings outlook.

So bottom line, we're according the way through our expectations are, you know, at or we're

likely to be better than what we've been assuming for ains this year. But you know, a lot will,

you know, this week with 40% and those hyperscalers reporting, that will kind of either affirm that

or suggest we're a little off base. Assuming it is affirmed, then again, it's sort of a

constructive view for equities, US equities in particular. So with that, Jason, let's end today,

as we always do with asset allocation, a good timing because I know the chief investment office

late last week released the latest house view update. What were some of the key messages within?

Well, we titled the main letter investing in a fast change in the world. I think it's that

and it goes without saying that these, you know, four months, nearly four months in the year,

like how much things evolve and continue to evolve on very kind of rapid, you know, time horizon.

Overall, it's still a constructive message that we think about the macro conditions,

you know, ultimately sort of positive on, you know, US economic growth on inflation. I've kind

of alluded to that in some of the prior answers. That still expect growth, at least in the US,

around 2% trend. Inflation looks like it's going to peak in the next couple of months. Certainly

tearful later inflation, you know, we'll go lower. You have a central bank, you know, on the Fed in

particular, it's looking to cut rates and other central banks that six weeks ago might have been

thought by the markets to be hiking rates this year. And I refer specifically to the ECB or the

Bank of England. Perhaps now what they do is, you know, they don't do anything at all. So that

is kind of getting us, you know, kind of a supportive, you know, you know, tailwind overall for

risk assets, earning stories is kind of unpositive. So this leads us to kind of the overall equity

messaging and kind of message is in general for, you know, across to Vanessa classes. I'll start with

equities, you know, the key message. There's a kind of diversified across equities. We've had a very

strong kind of balance back, you know, we've seen even in the past week or a couple of weeks,

very strong balance back in parts of tech and semi conductives in particular. This is all sort

of justified by kind of the macro fundamentals. We think the earnings stories overall and so sort

of remain constructive, but it would be cautious in terms of you not having over concentration

to those handful of companies or sectors that have done, you know, very well. And as a result,

thinking about diversifying within the U.S., diversifying within kind of the AI exposure,

diversifying kind of globally. And so the, you think about, you know, a core allocation,

one way to diversify is looking at more an equal weight allocation, you know,

which kind of moves you down the kind of the market capsize. You can also look at other markets

in Japan, emerging markets, especially Asia, have done very, very well. And like they are key

beneficiaries, you know, Korea, Taiwan, to the AI theme. Within sort of mega cap names,

it's for the AI value chain, you can get sort of diversifying to other areas, whether it's

industrials, automation, robotics, things like that. So it's not just a kind of a call,

specifically on, you know, hyperscalers. And then a last point, when we get these kind of rallies,

and again, we might see the price action this week in a post earnings, how they play out.

But given you, when you have these sort of rallies and bounce backs, you can use them as

opportunities for the rebalance into other strategies, other investments, you know,

including the sort of structure, you know, kind of solutions, all of which is sort of diversified

the portfolio, but also kind of protects it with a downside, given how fast things have come back.

So constructive your own equities by sort of, you know, diversify, don't be beholden to,

you know, the AI theme. On fixed income, you know, we've had a message for all kind of,

you know, steppin quality spreads of kind of come back quite a bit. So the kind of risk reward for

a lot of, you know, this corporate fixing income doesn't look particularly compelling,

rather take the equity exposure of corporate America than the credit exposure.

On kind of the rates front, you know, the market was going about a month ago,

pricing in some chance of a Fed hike this year. We think they're going to cut. We've

say that all along the markets, at least gone back to pricing at 50% chance of a cut this year.

We think the market will move more in that direction. So, you know, a message we have is

locking yields with the idea that, you know, where cash rates are now, they're probably going to go

lower. They're not going to go higher. And the market still isn't sort of fully kind of pricing for

that. So within fixed income, kind of favoring the front of the curve where we, you know, have more

conviction rates will, we'll go lower near term, the 10 year traded in between four, four and a

half kind of in the middle of the range, likely to stay there. So not looking to make kind of big

you know, calls there. It's part of the overall sort of fixed income landscape. I want to note that

we also upgraded munis to attractive last week. They ended up performed a little bit earlier in the

year. But we think they're now poised to deliver much stronger performance going into the summer.

They have a tax equivalent yield once you adjust for the tax differences versus say, you know,

treasuries or corporate bonds of over six percent. That's pretty attractive. The technical

sometimes are kind of weak, you know, especially around tax season. People have to pay the taxes. They

kind of hold off. Now that's done. They have capital to deploy. So as we move into the summer,

if that's kind of a better kind of season for kind of the technical story from munis. So

ultimately, we think they, you know, you have a chance to outperform certain attacks on a

global basis, you know, treasuries and investment-grade corporate bonds going forward. And finally,

just favorite commodities. You know, we've liked, you know, a variety of difficulties. We like

gold. We continue to like gold. And I think it will be kind of tailwind as interest rates go lower,

especially the front of the curve, but other, you know, you know, central banks and sovereign

wealth funds continue to add exposure. Industrial metals offer exposure to only things like,

you know, electrification and events where they build out of data centers. So it is, you know,

not just a gold call, it's sort of there's kind of broader exposure and environment where

people are looking for diversification portfolios. And because inflation resume elevated,

there's inflation shocks commodities can help diversify portfolios. Jason, thank you for dropping

by on this Monday morning, a busy week ahead. You think about all of the earnings results,

the FOMC meeting, and of course, keeping our eyes open for any further developments as it

pertains to the U.S. around war. So a lot to monitor helpful guidance reviewing the allocation

recommendations per the latest CIO House view. So thank you again, Jason, for dropping by.

You're welcome. Have a good week.

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