UBS “leapfrogged” – as Bloomberg called it – Bank of America as the world’s largest wealth manager with $1.7 trillion in assets, up 9.7% from a year ago. Global wealth management assets rose 8.7% to $18.5 trillion. These firms get to manage part of the wealth that central-bank policies have generated at the top. So they have some responsibilities, like helping their clients escape the sinewy arm of the taxman, driving valuations ever higher with their trillions – “doing God’s work,” as Goldman CEO Blankfein had put it so eloquently – and preserving their clients’ wealth when the going gets tough.
And UBS just warned in its latest Weight Watcher that the going will get tough. The report is subtitled chillingly, “We are worried. We reduce risk – for now.”
The warnings are surrounded by terms of flimsy optimism: “The world is slowly recovering and we do not think we are approaching the top of the cycle yet.” Or “the stock market should continue to rally.” These and similarly soothing terms are supposed to make us feel less panicky, apparently, about the harsh reality delineated in the report.
Turns out, “it is now time to scale down risk.” They’re “concerned about valuations.” They reuse Fed Chair Yellen’s term, but in a much broader sense, pointing out that “equity markets are stretched,” all of it, not just social-media and biotech stocks. The fixed income market and the credit market have become “quite rich.” A tsunami of capital washed into risky assets, and “the market might be ahead of itself.” In fact…
The market is “too complacent and could correct rapidly.”
There was already a first signal last week when the Banco Espírito Santo (BES) in Portugal blew up. It shouldn’t have mattered outside Portugal. Yet it hit hard “a variety of asset classes over the world.” UBS doesn’t think it was the start of another systemic banking crisis.
Rather we think the event tells us a story about market positioning and market pricing: we think the market is stretched. If this is true, the market is already pricing most of the potential good news and is prone to react to bad news.
Soothing words elsewhere to the contrary, UBS is getting cold feet about equities. “The recent momentum in markets is difficult to justify,” it warns. Among the indicators:
Our economic surprise index has been very highly correlated with the S&P 500 until the beginning of last year. Since then the market has continued his rally with little fundamental improvement to support it. This divergence is becoming uncomfortably large.
And UBS thinks one of the catalysts for a market correction could be “the disappointment” from corporate earnings reporting season. It’s particularly worried about the Q3 and Q4 outlook: “estimates seem to be too high, and we are starting to see companies spend less on buybacks (EPS supportive) and more on M&A.”
Conclusion? Trimming long equity positions “before the end of the year.”
Beyond equities, it’s even worse: “We don’t like credit,” UBS says categorically. In the US, it expects the default rate to increase “on a 6-12 month horizon,” causing spreads to widen – and losses for those who hold the paper.
Further, the market is “too sanguine on inflation” in the US and is underpricing inflationary pressures, which are “trending up.” The market has “a high conviction on a prolonged period of low inflation,” and is “not positioned for higher inflation.” Instead, fund-flow data indicates that “investors are selling their protection.” So UBS sees a “correction.” The “re-pricing” will be accompanied not only by higher rates, but also more volatility. It expects 10-year Treasuries to yield 3.4% by the end of the year, up from 2.48% today. Spreads will widen. In addition, “the Fed’s tone is changing,” and it could raise rates sooner and faster than is priced into the curve.
Alas, when the sell-off starts, UBS is “very worried” about “the lack of liquidity” in both the equity and credit markets – the latter being “the best example.” And then the warning: “We have severe doubts about the ability of market makers to provide liquidity in a volatile scenario. This would pave the way for an over-reaction.” In other words, havoc.
Conclusion? Underweight fixed income.
UBS conceded that it might get the timing wrong, “but we believe the risks are asymmetric. On balance we think it is time to be tactically low on risk.” And so: “We decide simply to reduce risk over the full spectrum of assets.”
When the largest player in the wealth management industry warns that all asset classes are overpriced and too risky and that it’s time to reduce exposure across the “full spectrum of assets,” and if in fact it starts selling some of its $1.7 trillion in wealth management assets in a market that is already lacking liquidity – that act in itself can trigger the very sell-off it is warning about. So fasten your seatbelts.
