These are the main talking points.
- From over- to underweight equities: Over the past week, we’ve gone from a modest overweight (2%) in equities to a modest underweight (-2%). The equity reduction was reallocated to fixed income (now +2% overweight), while cash went from a 2% overweight to neutral.
- The catalysts were rising trade tensions and policy uncertainty: The escalating US tariffs on China’s exports and China’s proportionate responses have created an environment of extreme policy uncertainty. The tit-for-tat dynamic suggests more escalation is very plausible, while the extreme uncertainty could cause the impact on growth to spread more widely across the economy. But the situation could also improve at any moment, as President Trump’s comments at the G7 Summit this morning demonstrate.
- Fed easing will help, but only modestly: We expect the Fed to cut rates three more times, starting in September, while other central banks are also likely to ease. This will mitigate some but not all of the trade-related economic slowdown. Easier monetary policy should also help cushion the equity downside. But its ability to reflate equities, as in the past, is limited by bond yields already being so low and the markets already priced for significant easing.
- It’s a small “risk-off” stance: We’re positioning for weakness in the global economic cycle, not an end to the cycle, with the TAA changes meant to neutralize event risk. We don’t expect a US recession next year. US economic fundamentals are still quite solid with a healthy consumer and no significant imbalances, which should enable it to absorb the latest tariff escalation. There are many risks, but we think the bull market will prevail after a period of rising market volatility and weakness. For the time being the US-China trade conflict will drive markets and it increasingly looks likely to get worse before it gets better.
- Don’t reduce the equity allocation expecting a bear market: It's completely normal for the market to decline 10% during the course of a year, so such a decline now wouldn't be unusual. But without a recession being our baseline forecast for the next 12-18 months now is not the time to significantly reduce the equity allocation. For perspective, the TAA changes over the past week reduced the total equity allocation in Moderate risk portfolios from 51% to 47%—a prudent “trimming of the sails” risk reduction, not a de-risking in anticipation of a recession.
- Don’t go to cash, but do review your plan: If you’re tempted to go to all cash, stop and first ask yourself what has changed about your long term investment plan over the past week that would warrant such a dramatic move. Now is a good time to review that plan with your UBS financial advisor and consider whether your liquidity strategy is sufficient to support your spending needs for the foreseeable future.
For more details on the specific allocation change within equities, fixed income and US equity sectors read the full, original blog, US TAA changes: What you need to know, 26 August 2019.
Main contributor: Jason Draho