House Call: Talking Equity Markets with UBS Asset Management

Hi everyone, Dan Cassidy here. Welcome back to House Call, Talking Equity Markets with UBS Asset Management. For today, I am joined by Jeff Hahn, Senior Portfolio Manager for the Houseview Equity Portfolios along with Dominique Shager, Lead Equity Investment Specialist, both joining us today from UBS Asset Management.

Adam will guide today's conversation with Jeff, focusing on recent market developments and how they're shaping the team's thinking within the Houseview Equity Portfolios. With that, Dom, Jeff, thank you both for dropping by and for spending some time today with our listeners. Adam, I will now turn it over to you.

Thanks, Dan. Thanks for having us on. It's great to be back.

Jeff, let's get started. So, despite geopolitical uncertainty, higher oil prices, and rising bond yields, U.S. equities have continued to rally, with the S&P 500 reaching new heights in May. Jeff, what do you see as the main drivers of the move and what has been the most notable about the breadth or the composition of this rally?

Hi, Dom. Yeah, so good first question for sure. I would say coming into the year, just taking a step back for a second, we felt like this was a good setup for markets.

You had fiscal stimulus that were coming through. You had less regulation for the banking system, which we felt could result in just some favorable lending activity moving forward. You had a lot of the tariff headwinds from last year fading.

On top of all of that, you had this continued expectation for massive AI spending. And so to your point, while the Middle East conflict created some noise during March, the market has really looked through that. I think really a big part of that is just simply that it seems that following the ceasefire, they could be coming closer to a potential agreement there.

But your question specifically on kind of what's driven things, and I alluded to some of the factors earlier, I think it really just comes down, more than anything, comes down to the AI spending that we've seen and really how much it's helping support economic growth and corporate earnings growth for that matter. So just sort of framing this for a second, last year, the hyperscalers spent about $500 billion of capital. And this year, they're estimated to spend an additional $700 billion.

There's some estimates that presume that that number could actually go up next year. This is just an enormous amount of capital that's being thrown around that's really trickling through into more parts of the U.S. economy. I've seen some estimates out there that show it's accounting for 75% of GDP growth, which would be up from kind of the contribution to growth that we saw last year.

And look, I think you've been seeing that through much of this year with some pretty healthy economic data. All that's certainly impressive, but I think you're also starting to see the benefits of this growth coming through in really in much stronger than expected corporate earnings. So just to frame that out a bit, the S&P earnings estimate revisions for 2026 went up 8% after companies reported in the first quarter, which is a pretty meaningful number for just one quarter of results.

And now projections are calling for S&P earnings growth in the low 20% range for this year. Prior to that, expectations were in the low teens range, so just sort of framing out that positive earnings revision and what it's leading to. And again, that's only after one quarter.

So again, pretty remarkable what we've seen there. Now when we think about what's behind this, we really have to look at where the AI spend is going, and that's into areas, sectors, industries with very high fixed costs that generate a lot of operating leverage. So think about semiconductors, think about technology storage and hardware, think about capital goods companies, and a number of those industries fall within the tech sector.

And so it's not surprising that tech stocks have once again really been the biggest driver of market performance this year, especially the semiconductor stocks who are seeing the largest earnings revisions across the board. And so just to look at performance as of I think yesterday, the S&P tech sector is up about 25% year to date. The S&P semiconductor industry is up 94% year to date, again, through yesterday, and that's well above what the market's giving you at about, the S&P's up about 10.

So pretty remarkable performance for that subset of the market, and I think that's, you know, to answer your question on really what's been the drivers, I mean, that's certainly been a really important driver for market gains this year. So Jess, building on your comments, markets seem to be leaning into resilient earnings, AI excitement, and shifting Fed expectations. But at the same time, there's geopolitical risk, particular around the straight-over moves and the resulting move in higher oil prices.

And we certainly see a lot of noise building in the background. How are you assessing the durability of this rally, and what is your base case, and how far the markets will evolve from here? Yeah, so I think if you go back over time, there's always a wall of worry, right?

And I think the market generally seems to be able to scale this. The degree of worry changes, you know, sometimes it's as extreme as COVID. And then most of the time, it's kind of what the environment that we're in today, and similar to last year where you had tariff noise and you had, you know, a huge curtailment of immigration.

Obviously, this year, you know, you have concerns around the Mideast conflict and the resulting inflationary pressures that we're seeing, and that's driven interest rates higher. Bears tend to point these issues out as real risk factors. But really, at the end of the day, you know, we try to stay focused on what matters most, which is the direction of earnings growth.

And that said, you know, look, we're very mindful of the market risks, and we're clearly paying close attention to what's going on with inflation and the resulting move higher in rates. But at the end of the day, as I pointed to earlier, the direction of earnings growth continues to be very supportive. You know, look, I'd say a lot of the concerns around inflation and interest rates is really tied into the Mideast conflict.

Based on news from this past weekend and really over the last few days, it appears that both sides continue to kind of inch closer towards some form of agreement where, you know, if that does end up being the case, that probably can help alleviate some of the inflationary concerns in the near term. And you've seen, you know, oil prices dropping recently. You've seen yields on the 10-year come in as well.

So, in a scenario where we think the tail risk to the market is getting a bit less noisy, we really just have to focus on what drives market performance. And as I mentioned, that's predominantly earnings growth. And so AI spend's certainly been a huge component of that earnings growth.

It doesn't appear to be slowing down anytime soon. And so, you know, our view, our projection is that strong growth can continue to support solid market gains ahead. Just worth noting, CIO recently raised their earnings growth forecast for the S&P to $335 a share, up from $310.

That implies about 20% year-over-year growth. And then for 27, they're assuming 12% S&P earnings growth on top of that, which is very attractive. And they also raised their target price on the S&P by year-end, $26 in conjunction with that.

So, look, I think all of this is telling you, yes, there's noise in the market. There always tends to be these wall of worries. Earnings are ultimately the big striver.

If we feel confident that, you know, that remains intact, then that can continue to support some pretty decent gains going forward. Let's stay on the topic of earnings. With the first quarter earnings season largely behind us, what stood out the most from your perspective, and how has it shaped your confidence in the underlying strength of the corporate fundamentals?

Yeah, I think, look, I think coming back to my comments earlier, just the magnitude of revisions is what stood out the most. 11 of the 11 S&P 500 sectors all delivered positive earnings growth year-over-year, and that's been the first time since I think it's been about four years where you've seen that. So, you know, thinking about sort of the stimulus for that, again, I think a lot of the A.I. spending that we're seeing is really just trickling through into broader parts of the economy. Now, you know, also responsible for that growth was just the move up in oil and commodity prices.

So you've seen energy, you know, the energy sector had strong revisions. Materials, which, you know, tends to, you know, move lockstep with certain commodity prices also has seen some decent revisions. But areas like industrials and areas within tech, you know, utilities, all, you know, these sort of, quote, old economy areas of the market seem to be really benefiting from all of this.

I'd say that was probably the biggest takeaway. The other thing I'd point out is, you know, the consumer, you know, as much as there's some concern out there on the consumer and you've seen some consumer sentiment metrics being, you know, pretty depressed historically, the consumer spend actually is holding up fairly well. I would note that most of the spending in our country tends to come from the wealthiest individuals.

And, you know, that cohort still has jobs and are seeing steady wage gains and, you know, tend to be spending as they have been. So despite higher oil prices, I think generally speaking, the consumer remains in pretty good shape. And we heard a lot of the banks talking about that.

A number of the consumer companies we own in our portfolios, while some of them noted the low end consumer continues to struggle a bit, broadly speaking, they're not really seeing much change in the way that consumers are spending. So Jeff, let's switch gears for a minute. Valuations and market concentration remain a common investor concern, especially given the role of AI, as you've discussed, in particular, the few leaders that have driven a lot of the returns.

How do you assess valuation risk today? And what do you see fundamental supporting some select exposure? Well, it's been interesting to see that this year, I mentioned the S&P is up roughly 10 percent.

All that's been driven by earnings growth, though, like the market multiple has actually declined year to date. So coming into the year, the S&P was trading around 22 times. You look at it today, it's closer to 21 times.

So just taking this a step further, the demand for AI related infrastructure just remains robust. And I think that's spanning across areas like compute and storage and memory and optical equipment and power. And yet it's very hard to see a commensurate level of supply increase to meet this demand.

And I think this is just resulting in an enormous amount of pricing power for these suppliers. Again, you really just have to keep in mind that these are industries with very high fixed costs. And so this strong demand and pricing increases are flowing through into some meaningful earnings growth.

So we just continue to believe the growth here should stay strong and can continue to support the valuations of these stocks. That said, AI spending is also having, as I mentioned just before, a bit of a trickle down effect into cyclical areas of the economy, too. So areas like industrials are starting to really benefit.

So think about, you know, so the companies that are really filling out the guts of the data center, as an example, with industrial components or heating, ventilation, air conditioning, equipment, cabling, electrical equipment. On top of that, financial stocks, financial is very cyclical, particularly capital markets oriented companies. They're also benefiting to a degree from this, right?

You're seeing an enormous amount of debt issuance to fund data center buildouts. Many companies are providing lending to help finance this growth as well. So while earnings revisions in the growth oriented segments of the markets have been strong, they've also been rising in the more cyclical areas as well.

Not at the same magnitude, but still the direction of travel there has been pretty positive. So broadly speaking, I'd say we're not overly concerned about market valuations. And we continue to believe that earnings growth broadly should continue to support equities.

Jeff, growth has dominated for much of the past five years, but leadership has broadened this year. As of close of May 26, the Russell 1000 value index is up roughly 13.8 percent year to date, all performing the Russell 1000 growth index, which has returned around 6.4 percent. How are you thinking about the growth versus value debate today?

And in your opinion, what conditions we need to be in place for a more durable rotation into value? So at a high level, I think it makes sense to have balanced exposure to equities across styles. And that was true last year.

The Russell 1 growth was up 18.6 and the Russell 1 value was up just under, just around 16 percent. So it's a pretty balanced year. And to your point, this year value is outperforming, though that gap has closed meaningfully just in the last two months.

But I'd say year to date, much of the strong performance in the value index has come from energy and material stocks. And I pointed out that commodity prices have moved higher. You've seen some pretty powerful revisions in those parts of the market.

But we've also seen really strong gains in cyclical segments within technology. So semiconductor storage and hardware, which account for a decent amount of the value tech sector. I'd say looking ahead, there's probably two catalysts that we think can support value stock performance.

Say the first would be a firm resolution in the Middle East, which probably could support a higher valuation for value stocks. There seems to have been some investor worry of late that higher oil prices could crimp economic growth. And I think that's led to value lagging growth pretty sharply over the past couple of months.

So I think a bit more certainty that oil prices won't get out of control really might give investors more confidence to revisit some of the beaten up cyclicals within the value index. I'd say the second catalyst would probably just be the healthy earnings growth that I alluded to earlier. For the Russell 1000 value, earnings growth rose about 8 percent last year, and this year it's estimated to rise about 18 percent.

And you've had some pretty strong revisions within the Russell 1 value index there as well. And that would be the 18 percent growth this year, if that holds, would be the highest rate of growth in well over a decade for this index. Excluding the year after covid, and it would be a pretty meaningful step up, certainly compared to last year.

Again, looking at where the revisions are coming, energy materials and tech, I'd say energy materials account for about 12 percent of the Russell 1000 value. It's, you know, 5 percent or so roughly of the S&P. So pretty meaningful contributor to the value index.

And then just finally, when you listen to some of the more cyclical companies in the value index, so analog semiconductor companies, they're seeing strong order growth. The railroads are seeing improving volume trends. We're hearing some industrials talking about a modest recovery in non-residential and commercial construction markets.

So I think, again, earnings could support, you know, continued or just general could provide somewhat of a tailwind for the value index and value stocks in general this year. So just sort of summing it up. Yeah, we think the backdrop for both growth and value remains supportive.

I think you saw that last year. We think that's true once again this year. And so, you know, I think just for advisors that, you know, have big overweights to growth, just given the leadership over the last decade plus, it could make sense to consider having some more balance in client holdings.

Great. Well, Jeff, thank you again for joining us and for sharing your insights. Thank you for tuning in.

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