Analysts at UBS are forecasting a potential rally in US stocks as the year draws to a close, driven by seasonal trends and strong investor confidence. However, they caution that the rally might not be smooth, as there is a risk of sudden price spikes that could cause unexpected market swings.
UBS’s latest report points to several positive indicators supporting a rise in stock prices, including typical year-end patterns, upbeat sentiment in the options market, and signals from UBS's own investment models. Taken together, these factors suggest that stock prices could "grind higher" in a steady but modest rally. Yet, the analysts warn that if prices climb too quickly, it could lead to a sharp jump in market volatility—measured by the VIX index, often referred to as Wall Street's "fear gauge."
Essentially, if the market rises too fast, investors could see volatility rise right alongside it, similar to what happened in early 2018, UBS strategists wrote. They explain that if stocks surge too quickly, the VIX could move up even as prices climb, which often signals potential instability.
However, UBS’s view is that a rapid "melt-up," or sudden, sharp increase in stock prices, is not likely. Current market conditions suggest only moderate gains, especially as many big investors are already heavily invested in stocks. The firm also notes that much of the "Republican sweep" effect—expectations that a recent shift in US government leadership might boost markets—has already been priced in, leaving less room for sudden growth.
Although UBS’s outlook is generally positive, the analysts advise keeping an eye on economic trends that could drive markets higher than expected. Specifically, stronger growth and inflation could fuel the rally but might also bring increased volatility, especially in sectors like Oil & Gas, which could benefit from rising energy prices.
To prepare for a year-end rally with a possibility of volatility, UBS recommends two strategies for investors:
Consider VIX Downside Puts: UBS suggests that investors who expect volatility to decrease could look at options that benefit from a decline in the VIX. This trade could pay off if the market's upswing is steady and doesn’t see a lot of price swings.
Use S&P 500 Call Spreads: UBS also recommends using S&P 500 call spreads—options that can help capture gains if the market climbs. They suggest sticking to basic 1:1 call spreads, as they offer a simpler way to profit from rising prices without taking on too much risk in case of a big, unexpected jump.