Thought of the day

What happened?
The S&P 500 climbed 9.5% on Wednesday, its largest daily gain since 2008, after US President Donald Trump announced a 90-day pause on “rec iprocal tariffs” for countries that had so far refrained from retaliating. The Nasdaq index rallied 12.2%, its best single-day gain since 2001.

The bounce carried through to other regions on Thursday, with the Taiwan benchmark surging 9.2%, Japan's TOPIX up 8.1% and South Korea's KOSPI up 6.6%. In Europe, the Euro Stoxx 50 rose 5.6% in early trading. However, S&P 500 futures for Thursday's session are trading 2.3% lower at the time of writing.

Trump's statement on Wednesday kindled hopes of averting a global trade war. However, the president singled out China, the largest exporter to the US, and subsequently raised US tariffs to 125%, up from 104% earlier in the day. In addition, the White House stressed that the “baseline” 10% tariff on imports from most other nations would remain in effect during the 90-day pause. This follows Tuesday’s executive order tripling the tariff on smaller parcels from China valued at less than USD 800 from 30% to 90% effective 2 May—a move that affects an estimated USD 40-45 billion of annual imports, chiefly through e-commerce channels.

The shift in US policy came after further signs of escalation earlier in the day, with both China and the EU unveiling higher tariffs on imports from the US. Trump also reiterated Wednesday that he would soon unveil levies on the pharmaceutical sector, which has so far been exempt. The pharma sector underperformed the broader market on Wednesday, rising 2.8%.

There were also signs earlier in the day that the uncertainty around trade had started to generate instability in the US Treasury market. The 10-year Treasury yield rose as high as 4.51% after trading as low as 3.87% on Monday—a pattern that goes against the grain of normal safe-haven inflows into US government bonds. Reports of foreign selling, a flight to liquidity, and hedge funds unwinding leveraged “basis trades” added to the pressure. Conditions have since improved, with the 10-year Treasury yield falling to 4.28% early Thursday, in part owing to strong auction demand yesterday.

What do we expect?
Market volatility is likely to remain elevated in the weeks ahead as investors assess rapidly shifting tariff developments and consider the potential implications for growth, inflation, central bank policy, and financial markets.

Our base case (50% probability) has been for higher tariffs in the near term, followed by gradual rollbacks as political, business, and legal challenges mount, trading partners offer concessions, or as popular support for the Trump administration falls.

Trump’s post on Wednesday opens the door to potential tariff reduction “deals” for many trading partners. We believe this approach from the US administration is consistent with an “escalate to deescalate” strategy toward much of the world.

At the same time, we remain mindful of the greater-than-expected escalation between the US and China, and it is not certain that the pause in “reciprocal tariffs” on other trading partners will hold.

Despite Wednesday’s announcements to lower the “rec iprocal tariff” rate for most countries to 10%, the escalation between the US and China could dramatically impact trade between the world's two largest economies. We currently estimate the overall US effective tariff rate at 27% (versus 9% prior to 2 April). Excluding trade with China, the effective tariff rate is 11%.

In our base case, we expect tariff moderation and Federal Reserve rate cuts to support a rebound in the S&P 500 to 5,800 by year-end, despite slowing US growth. We see the 10-year Treasury yield declining to 4.0%.

In an upside scenario (20% probability), equity markets continue to rebound sharply amid a more permanent resolution of trade disputes, the avoidance of a material slowdown in growth, and optimism about the impact of AI on earnings. In this scenario, the S&P 500 ends the year around 6,500.

In a downside scenario (“hard landing;” 30% probability), the pause in tariffs ultimately does not hold and tit-for-tat retaliation resumes. Weak demand leads to a severe US recession. S&P 500 levels in the 3,500-4,500 range would be consistent with historical recessions. We believe the 10-year Treasury yield would drop to 2.5% in this scenario.

How to invest?
The rebound in global markets offers investors an opportunity to take stock, diversify portfolios, and prepare for what we still believe is likely to be a volatile second quarter, while positioning for what we still expect to be longer-term equity gains..

Review your plan. The recent market swings have underlined the appeal of the UBS Wealth Way* approach, which helps families segment their wealth—based on their purpose and time horizon—into three strategies using the Liquidity. Longevity. Legacy. framework. Investors with a well-funded Liquidity strategy can confidently look through volatility and focus on action items within their control.

Navigate political risks. Investors whose discomfort at recent stock volatility tempts them to sell into strength risk foregoing future gains. Another way to navigate political risks and bouts of volatility while staying invested may be substituting existing direct equity exposure for structured strategies with capital preservation features. Despite falls in major sovereign bond yields to pre-"Liberation Day" levels in some major markets, interest rates still remain elevated relative to recent history, leading to relatively appealing pricing on capital preservation approaches.

We also believe gold will continue to offer portfolio diversification benefits, particularly in adverse scenarios. In our base case, we target gold prices of USD 3,200/oz.

Seek durable income. The increase in bond yields in volatile trading in recent days offers investors respectable total return potential with added diversification benefits for portfolios. In a downside scenario we would expect 10-year Treasury yields to fall to 2.5%, offering potentially significant capital gains for investors. Investors at the longer end of the yield curve need to remain mindful of volatility related to fiscal concerns and the unwinding of technical hedge fund “basis trades.”

Diversify with hedge funds. By dynamically adapting to macro shifts, hedge fund strategies like discretionary macro, equity-market neutral, select relative value, or multi-strategy can cushion portfolios in volatile and down markets, and potentially prosper amid a fast-changing macroeconomic environment.

Look through volatility. We continue to see strong long-term potential in our Transformational Innovation Opportunities (TRIO)—Artificial intelligence, Longevity, and Power and resources. While companies exposed to each of these ideas have been caught up in near-term derisking, we expect structural trends to be the biggest drivers over the long term.

Investors can manage market timing risks while building up allocations through phasing approaches. Since 1945, we find that a strategy to phase into a balanced 60/40 portfolio of S&P 500 and US government bonds over the course of 12 months and then holding has outperformed cash (three-month Treasury bills) in roughly 74% of one-year periods and around 83% of three-year periods. Strategies which started to phase into 60:40 diversified portfolios when the S&P 500 is more than 10% off its peak have outperformed cash in roughly 82% of one-year periods and approximately 94% of three-year periods ( click here to read more on phasing into markets).

Trade the range in currencies. In the near term, we see an opportunity to benefit from currently elevated levels of currency volatility by trading what we expect to be near-term ranges in key pairs, including EURUSD (centered around 1.10), USDCHF (centered around 0.86), and GBPUSD (centered around 1.31).

Over the medium term, we believe a more sustained period of weakness for the US dollar is likely, particularly if the Fed cuts interest rates more quickly than expected in response to weakness in US economic growth. Investors looking to position for longer-term dollar weakness while monetizing short-term volatility can consider selling the risk of a higher US dollar.

*UBS Wealth Way is an approach incorporating Liquidity. Longevity. Legacy. strategies that UBS Financial Services Inc. and our Financial Advisors can use to assist clients in exploring and pursuing their wealth management needs and goals over different time frames. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved. All investments involve the risk of loss, including the risk of loss of the entire investment.