Seeking direction

Where we are now

Global equities have seen 17 days with a greater than 1% move up or down so far this year, compared with just three in all of 2017. Yet, having traded within a 10% range, global equities are roughly flat year-to-date. Behind this volatile and directionless trading pattern are at least three areas of heightened uncertainty: geopolitics, trade, and interest rates. The question of the day is not whether or not the market will break out of its trading range – it's whether the next move is up or down.

Mark Haefele

Chief Investment Officer

UBS Global Wealth Management

The base case: Markets will go up

Our base case is represented by the green path. We believe fears of tighter monetary policy, a trade war, and geopolitical shock will ease in the coming months, allowing investors to refocus on strong corporate earnings and economic growth.

Healthy earnings growth

We project S&P 500 earnings per share to rise 20% for 1Q18, the fastest growth since 1Q 2010.

Strong economic fundamentals

We forecast real US GDP growth of 2.8% in 2018 and 3.0% in 2019, the strongest 2-year period of growth since 2005-2006.

Fading fears

We do not believe airstrikes on Syria will negatively impact markets, a trade war will escalate between the US and China, or the Federal Reserve will hike rates faster than the economy can handle.

Risk cases: What if we're wrong?

Of course, it’s possible the red path will occur. As such, we need to consider the probability and potential consequences of adverse scenarios. We see three main low-probability risk scenarios:

Trade war

20-30% probability that a trade war between the US and China slows global growth.

Geopolitical shock

20-30% probability that fears over disruptions to global energy supply lead to a sharp rise in oil prices.

Rapid interest rate rises

10-20% probability that the Fed hikes rates 6 times – instead of the 4 that we expect – over the next 12 months, leading to fears of slower growth.

How should investors be positioned?

For our base case

Given our view that markets will grind higher, we remain overweight global and emerging market equities.

In case we’re wrong

We prepare for the possibility that the next market move will be “down” by holding counter-cyclical positions, including an overweight in US 10-year Treasuries. We also recommend that investors consider hedging options.

While the market lacks direction

In addition to counter-cyclical positions that can help us smooth out volatility, it's important to remember that portfolio management strategies like rebalancing and tax-loss harvesting can help investors take advantage of volatility.

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