UBS: Clients are unwilling to chase high U.S. stocks, and going long on emerging market stocks is the consensus

According to the Zhitong Finance APP, UBS has released a research report stating that while market sentiment has improved, investors are still reluctant to chase higher prices. The speed of the S&P index rebound has surprised New York investors, with most shortening their investment horizons to a few weeks and reducing position sizes. Against the backdrop of alleviated extreme downside risks, family offices are turning to developed market stocks (planning to increase allocation from 26% to 29%), while also suggesting to focus on stocks benefiting from the repatriation of U.S. manufacturing, going long on the front end of the USD/HKD forward curve, and warning that fiscal deficits are pushing up global long-term government bond yields. The strategy indicates that artificial intelligence (AI) stocks are favored in the Hang Seng Index market, and the trend of structural changes in the stock market may continue. They prefer core holdings that are more liquid and favored by foreign investors.

UBS's main points are as follows:

This weekend, UBS's trading desk published an article noting that client sentiment is no longer as pessimistic, but it seems no one is willing to chase higher prices. There are several core observations: first, family offices are turning to developed market stocks; second, stocks benefiting from the repatriation of U.S. manufacturing should gain from adjustments in depreciation policies; third, concerns over fiscal deficits are pushing up global long-term government bond yields; fourth, rising Japanese government bond yields are favorable for the yen; fifth, it is recommended to go long on the front end of the USD/HKD forward curve, expecting Hang Seng Index constituent stocks to outperform A-shares.

Client sentiment is no longer as pessimistic, but no one is willing to chase higher prices

New York investors are surprised by the speed and magnitude of the S&P index rebound, complicating decision-making as most remain concerned about the lagging effects of trade policies. As a result, they have shortened their investment horizons from several months to a few weeks and significantly reduced position sizes. Nevertheless, the extent of the rebound has forced investment prospects to become less worrisome. Most believe that extreme downside risks have been alleviated, expecting a slight economic slowdown, but not a more severe one; no one believes that the U.S.'s superior position has come to an end.

While few are willing to buy at new highs, most now hope to buy on dips; a minority hopes to build positions at 5800 points, while most prefer to build positions between 5600-5500 points. Short-term sentiment is constructive, but few expect the S&P index to exceed the historical high of 6147 points.

Meanwhile, U.S. Treasury yields have become a focal point, with all clients concerned about the trajectory of the budget deficit. Almost no one opposes the bank's expectation that the yield on the U.S. 10-year Treasury will rise to 5% by the end of the year. Almost no one expects the Federal Reserve to cut rates this year. Meanwhile, Europe is hardly mentioned. UBS clients prefer Japan over Europe, as most believe the U.S. government will offer more favorable trade agreements than with the EU. Going long on emerging market stocks is a consensus, especially in China.

Family offices are turning to developed market stocks

UBS has released the "2025 Global Family Office Report," based on insights from 317 single-family offices. Respondents represent approximately $651 billion in family wealth, with an average of $2.7 billion per office. The primary risks identified for 2025 include global trade wars, significant geopolitical conflicts, and high inflation. Despite these concerns, 59% of family offices plan to maintain the same level of portfolio risk over the next 12-18 months It is worth noting that family offices are shifting towards developed market equities (26% of portfolios in 2024, planned to increase to 29% in 2025), driven by structural growth opportunities. Family offices are also increasing their exposure to private debt (doubling to 4% in 2024) in search of additional returns. There is a clear shift from viewing sustainability as a risk constraint to seeing it as an opportunity. More than one-third of family offices are involved in clean technology, green technology, or climate technology. Just over half of the surveyed families have established formal wealth succession plans, highlighting the ongoing demand for structured long-term planning.

Stocks benefiting from the reshoring of U.S. manufacturing are expected to gain significantly from depreciation policy adjustments.

Analyst Amit Mehrotra is highly focused on new tax legislation, which he believes could incentivize a revival of U.S. manufacturing. This includes restoring the bonus depreciation rate to 100% (currently at 40%) and allowing full depreciation on investments in new factory structures or buildings (currently not counted as bonus depreciation). The Trump administration is seeking to include this, and Amit believes it will incentivize a revival in U.S. manufacturing construction. If businesses are allowed to immediately expense investments in new manufacturing plants, it could increase the internal rate of return (IRR) by 50% (400 basis points). This is a significant growth relative to their capital costs and should accelerate the reshoring of capacity.

His analysis compares cash returns over 20 years under two scenarios: 39 years of straight-line depreciation and 100% depreciation in the first year. If the bill becomes law, this represents a meaningful growth relative to capital costs and should incentivize more U.S. manufacturing. UBS's U.S. reshoring basket (UBXXSHOR) has the potential to be a major beneficiary of tax reform.

Concerns over the fiscal deficit are pushing up global long-term government bond yields.

Last week, the yield on the U.S. 30-year Treasury bond reached 5.15%, the highest level since October 2023. The House's tax bill and Moody's downgrade have raised investor concerns about U.S. fiscal sustainability. The committee responsible for the federal budget estimates that the tax bill will increase U.S. debt by $3.1 trillion over the next decade, a 9% increase over the current debt burden.

Many investors believe that Moody's downgrade will not trigger any meaningful sell-off of U.S. Treasuries, as S&P and Fitch downgraded the U.S. years ago. However, the Philippine central bank has explicitly stated that they are considering reducing their $60 billion Treasury holdings following the downgrade.

The U.S. is not alone; Japanese government bonds are also facing selling pressure. Since May, the yield on Japan's 30-year government bonds has risen by 35 basis points following lackluster 20-year bond auctions and Prime Minister Kishida's comparison of Japan's fiscal situation to Greece. Despite liquidity issues facing Japanese government bonds, the Bank of Japan has stated that higher yields will not prevent them from conducting quantitative tightening. Given the sharp rise in yields, Japanese life insurers like Sony Life have indicated they will sell some of their Japanese government bond holdings to avoid further losses Due to weak demand for Japanese government bonds, next week's auction of 700 billion yen (approximately 5 billion USD) in 40-year Japanese government bonds will be challenging and may trigger another wave of global bond sell-offs. In an environment where the safe-haven status of government bonds is challenged by broader fiscal deficit issues, gold will continue to benefit.

Rising Japanese Government Bond Yields Favor the Yen

With global long-term bonds under pressure, Japanese interest rates are particularly strained, with the yield on 35-year bonds currently at 4.5%, up from 3.1% at the beginning of the year. Given that only a small portion of the debt is held by foreign investors and its net international investment position is one of the strongest among G10 countries, a sovereign debt crisis remains unlikely.

However, the weak demand for the 20-year Japanese government bond auction surprised the market, and the liquidity environment for Japanese government bonds has become difficult: insurance companies completed years of long-term Japanese government bond purchases at the end of last year in anticipation of regulatory changes taking effect this year, while the Bank of Japan is reducing its Japanese government bond purchases by 400 billion yen each quarter through the first quarter of 2026. Although the Bank of Japan stated this week that there is no need for significant adjustments to this plan, investors will seek further clarification at the June meeting.

In the short term, attention turns to this week's auction of 700 billion yen in 40-year Japanese government bonds. As the market discovers yield levels without intervention from the Bank of Japan, the risk clearly leans towards rising Japanese government bond yields. However, the speed and magnitude of this adjustment remain uncertain. Rather than expressing this view through interest rates, foreign exchange may offer clearer trading opportunities. With the risk of a debt crisis being minimal, as Japanese government bond yields rise, domestic fixed income becomes more attractive to local investors, especially as U.S. assets begin to lose appeal, the USD/JPY may face downward pressure.

Long the front end of the USD/HKD forward curve; Hang Seng Index constituents outperform A-shares

Asian foreign exchange volatility has generally retreated from early May highs, but beneath the surface, the recent performance of the Hong Kong dollar has drawn market attention. When the Hong Kong dollar appreciated significantly alongside broader Asian currencies, the Hong Kong Monetary Authority intervened to defend the strong side of the USD/HKD peg (7.75-7.85). This intervention led to a quadrupling of excess liquidity in banks, driving front-end rates sharply lower. As Hong Kong dollar arbitrage trades fell to historical lows, the currency has moved significantly towards the weak side of the peg at 7.85. Upon reaching this level, the intervention measures from early May will be reversed, meaning the Hong Kong Monetary Authority will withdraw excess liquidity and push up the Hong Kong Interbank Offered Rate (HIBOR). This presents an opportunity for investors to go long the front end of the USD/HKD forward curve, anticipating HIBOR normalization. The upcoming wave of corporate dividend payments also provides supportive tailwinds for this trade.

In the stock market, a structural shift is also underway. Since September last year, the premium of A-shares relative to Hang Seng Index constituents has been steadily compressing. The AH premium index is currently around 33%, close to the bottom of its five-year range and near the approximately 20% highs seen in the years prior to MSCI inclusion The strategy indicates that due to the easing of trade negotiations, lower expectations for policy stimulus, tariff risks, and the delisting of American Depositary Receipts (ADRs) no longer being a topic in the short term, along with the preference for artificial intelligence (AI) stocks in the Hang Seng Index market, this trend may continue. They prefer core holdings that have better liquidity and are favored by foreign investors.