UBS warns of stock market volatility ahead amid trade, fiscal policy uncertainty

UBS strategists anticipate continued market volatility due to uncertainty surrounding U.S. trade and fiscal policy, despite a recent market recovery. While trade tensions have eased with a U.S.-China truce, the analysts project a significantly higher effective U.S. tariff rate of around 15% compared to pre-Trump levels, and also highlight concerns over a worsening U.S. fiscal outlook due to proposed tax cuts potentially adding trillions to the national debt. Despite these headwinds, UBS does not foresee a recession this year and recommends strategies to manage volatility, including phasing into the stock market, diversifying with quality bonds, gold, and hedge funds, projecting a higher S&P 500 and lower 10-year Treasury yield over the next 12 months.

Analysis

Strategists at UBS anticipate continued stock market volatility driven by significant uncertainties surrounding U.S. trade and fiscal policies. Despite a recent six-session winning streak in the S&P 500, which suggested a Moody's U.S. credit rating downgrade was not a surprise, the outlook remains clouded. Trade tensions persist, with markets seeking evidence of new deals before a reciprocal tariff delay expires in July and a U.S.-China trade truce ends in August; universal 10% U.S. tariffs and other levies on items like steel and aluminum remain active. UBS's base case projects the U.S. effective tariff rate to reach approximately 15%, a substantial increase from the 2.5% pre-Trump administration rate. Concurrently, concerns are mounting over a deteriorating U.S. fiscal outlook, with a proposed budget bill potentially adding $3 trillion to $5 trillion to the existing $36.2 trillion national debt, and large tax cuts possibly pressuring bond markets by increasing Treasury supply. Notwithstanding these headwinds, UBS does not foresee a U.S. recession this year and expects the Federal Reserve to maintain current interest rates in the near term. The firm projects the S&P 500 will edge higher over the next 12 months, while the 10-year Treasury yield is expected to fall.

Key Decisions for Investors

• Investors should anticipate sustained market volatility and consider strategies to manage this, such as phasing into equity positions to capture medium- to longer-term gains while mitigating timing risks.
• Employ capital preservation strategies to navigate potential near-term stock market declines resulting from trade and fiscal policy uncertainties.
• Enhance portfolio diversification by considering allocations to quality bonds, gold, and hedge funds, in line with UBS's recommendations for navigating the current uncertain environment.