Investing.com -- UBS strategists see a potential year-end rally in US equities, driven by a combination of seasonal trends, strong investor sentiment, and the possibility of reduced market volatility.
The investment bank notes that market volatility has eased following the US election, setting up conditions that could lead to a significant upsurge as investors welcome stability.
UBS highlights that investor sentiment has turned bullish, especially in options markets. This optimism is buoyed by the “confluence of seasonality,” which historically has seen the highest US equity risk-adjusted returns in November and December.
UBS's Early Warning Signal (EWS) framework supports this view, pointing to favorable conditions that could continue to lift the S&P 500 index.
However, UBS strategists emphasize that the pace and sustainability of the rally will be key in determining if volatility remains muted or sees a resurgence.
While acknowledging the possibility of a rapid “melt-up” scenario, it is not their base case.
“A market melt-up scenario could see fixed strike implied volatility reset higher, not lower ('spot up, vol up'),” strategists led by Maxwell Grinacoff said. “This could keep a bid to VIX in tandem, similar to dynamics witnessed in January 2018 post the passage of the Tax Cuts & Jobs Act (TCJA).”
Strategists previously flagged a rising risk of economic overheating, with both growth and inflation expectations trending upward. They continue to favor beneficiaries such as Oil & Gas Exploration & Production companies, though they believe this is unlikely to lead to a broad market melt-up.
Instead, UBS’s team leans towards a gradual “market grind-up” into year-end, given that key investor positions are already “max long,” and the expected squeeze risk is largely moderated by dealer gamma positioning.
“We thus maintain our view that VIX could re-test YTD lows into year-end,” strategists concluded.