What's takeaway 1 on House Call?

U.S. equities have shown resilience, recovering from volatility early in 2025.

What's takeaway 2 on House Call?

The technology sector's performance is closely tied to the ongoing AI narrative.

What are the market implications for House Call?

Traders should monitor developments around Federal Reserve meetings and any associated guidance on rate adjustments, as these will be crucial in shaping dollar strength. Watching the S&P 500's trajectory could also serve as a proxy for potential shifts in FX valuations, particularly against pairs affected by risk sentiment, such as EUR/USD.

What are the risks to this view on House Call?

A shift in Fed policy that signals a more hawkish or dovish approach than currently anticipated could undermine the bullish narrative supporting the equity rebound, leading to a reassessment of dollar strength. Additionally, unforeseen macroeconomic shocks could reignite volatility, impacting both equity and currency markets significantly.

House Call: Talking Equity Markets with UBS Asset Management

What the desk is arguing

The overarching message is one of cautious optimism regarding U.S. equities, suggesting a recovery trend that could influence currency movements. The synergies between equity performance and currency valuations, especially in a higher interest rate environment, highlight a thematic pivot in investment strategy. Per the full note source, Zirin specifically noted the stabilization in equity markets after a mid-year recovery, which has implications for the USD as an investment vehicle.

Key indicators contributing to this viewpoint include the reported 25% rise in the S&P 500 over the prior two years, even after encountering a drop of about 5% earlier this year. This resurgence, particularly in technology, is being bolstered by ongoing advancements in artificial intelligence that promise to revive investor confidence. These multifaceted conditions suggest that U.S. equity dynamics could positively impact the dollar's value as capital flows into perceived safe havens during periods of uncertainty.

Market participants may have expected a prolonged downturn, but the quick recovery challenges this pessimism. A reversal in this sentiment could materialize if upcoming Fed decisions on interest rates do not align with market expectations, marking a potential inflection point for FX strategies.

Hi everyone, Dan Cassidy here. Welcome back to the UBS Market Moves podcast channel. We are back with another episode of House Call, talking equity markets with UBS Asset Management.

Joining us for the episode this month, glad to welcome back Jeremy Zirin, Senior Portfolio Manager of the Houseview Equity Portfolios and Head of the Private Client U.S. Equity Team with UBS Asset Management. Jeremy, great to be with you today.

Thank you for dropping by, spending some time with our listeners, our clients. So welcome back. Great to be back on, Dan.

So I know there's a lot we want to cover with our listeners today. As we're speaking, Jeremy, at this point we have passed the midpoint of 2025. It is notable that despite a negative first quarter and the significant market decline in April caused by tariffs, U.S. equity markets ended the first half of the year in positive territory and have continued to climb in July.

So to begin our discussion today, could you please share your insights on the principal factors that have contributed to the market's recovery in recent months? Sure. Well, the first half of the year certainly was far more eventful and more volatile than was anticipated going into the year.

But maybe just taking a step back, Dan, I think it's helpful to remember that coming into this year, the S&P was up roughly 25% each of the past two years. So from that perspective, it wasn't too surprising that the rally paused a bit in the first quarter of the year and the S&P fell about 5%, particularly after the Chinese deep-seated model surfaced and investors in some of the market's biggest tech heavyweights started questioning the sustainability of the AI narrative, which has been such a powerful market driver over the past two years. Then, as we discussed on prior calls, as most of us painfully remember, volatility really spiked in early April when markets fell sharply after Liberation Day and at the beginning of April when much higher than anticipated reciprocal tariffs were announced.

What's been surprising to many, including us, frankly, has just been how strong the rally has been over the past two-plus months. Since the 2025 market low was reached on April 8th, stocks have rallied 24% through the end of the second quarter. And as you mentioned, they just continue to climb here in July, reaching all-time highs.

So maybe to directly answer your question, Dan, I said that there were four primary factors or drivers as to why, despite all the volatility and lingering uncertainties over tariffs, that markets have bounced back so strongly. First, on tariffs, markets have been relieved that, at least so far, we've avoided worst-case outcomes. After Liberation Day, investors were worried that the effective tariff rate could be as high as 25% to 30% and that a policy-induced recession was likely.

Reciprocal tariffs were at first delayed three months to July 8th and subsequently delayed again to August 1st. For most countries, for China, it was delayed to mid-August. So now investors are gravitating towards the assumption that the end policy goal here isn't implementing sky-high tariffs, but negotiating bilateral deals so that the U.S. can still perhaps get some tariff revenue, but also greater access to foreign markets or some other measures, such as foreign purchases of U.S. goods, that can ultimately reduce our overall trade deficit.

The second factor is simply that U.S. economic data continues to be resilient. Despite big declines in consumer and business sentiment data, or what we call the soft data, the hard data, or actual data, has held up surprisingly well. And so if you look at non-farm payrolls, they've gained, on average, $130,000 per month through the first six months of this year.

That compares to about $160,000 last year, so a small deceleration, but nothing that looks overly foreboding. The unemployment rate remains low at 4.1%, leading indicators of the labor market, like initial jobless claims, have picked up a little, but you've got to squint, really, to see anything in the long-term trend line that looks like it could be leading to something, anything close to a recession. Similarly, consumer spending has been also quite resilient.

You look at retail sales data, for most of the year, we've been pretty much in the 3% to 5% year-on-year growth range. And the latest readout in June has been right in the middle of that range at 3.9%, so no real slowdown that we've seen in consumer spending. Looking at inflation, the core PCE inflation gauge, which is the Fed's preferred measure of inflation, has decelerated from 2.9% to 2.7%, so we're not seeing a lot of tariff impact impacting overall gauges of inflation.

And so putting that together, resilient growth and somewhat moderate inflation is a very equity-friendly cocktail. Third positive driver has been the corporate profit cycle, obviously related to the economy, but not the same. And to be sure, tariffs at some point may start to impact corporate profits, specifically corporate profit margins, but we're not seeing it yet.

In the first quarter, S&P 500 earnings were up 12%, and while it's still early in second quarter earnings season, earnings look to be on track for high single-digit growth this quarter. And everyone is looking at forward guidance to see if companies are starting to slash their forward guidance in anticipation of a slower economy because of tariffs, and that's not happening. We've actually seen forward 12-month earnings estimates for the S&P 500 have moved up by about 4% this year, from $274 to $285.

And then lastly, we've also talked in past calls about the high level of concentration in the U.S. equity market. Currently, the top 10 companies, or just 2% of companies in the S&P 500, comprise 38% of the market cap of the S&P 500. And the rebound that we've seen in the market has been led by some of those big mega cap stocks that have contributed more than the overall market gains and more than the market overall rebound, that 24% figure that I cited.

So Jeremy, thinking about your comments on the resiliency of the economy in particular, how do you expect the economy, and perhaps more importantly, the profit cycle to progress in the second half of the year? And I'm curious, will tariffs start to take a bigger bite? Overall, from everything that I'm seeing, I'm somewhat optimistic on the economic outlook.

The effective tariff rate ultimately lands in the 12% to 15% range. That would be an economic drag, but it should be a manageable one. So in my view, we're likely to see the economy downshift or decelerate a bit to a slower gear, but in my base case, we should be able to avoid a recession.

In terms of timing and the impact of tariffs, I would expect to see tariffs start to have a bigger negative impact fairly soon. Remember that the higher reciprocal tariffs have been threatened, but not fully implemented. Because of that, companies pre-bought a lot of goods in anticipation of higher tariff rates.

And many of those companies are still working off that lower price inventory. And so that's one of the reasons why we haven't seen a significant impact yet on inflation measures and frankly, even on overall real consumption. When that gets exhausted, if we do in fact get those higher tariffs implemented, we should start to see at least some greater pass-through of the higher prices resulting in lower real consumption and a little bit of an uptick in inflation.

That being said, I think it's important to recognize that there's still a lot of uncertainty over the final landing spot for tariffs. The good news perhaps is that the administration does seem to be making progress in negotiating deals as we've seen recently with Japan. And perhaps more broadly, there's been what I call a policy reaction function to avoid the worst case scenario, given the willingness and track record of President Trump to delay the implementation of some of the more harmful tariffs.

Some in the press have called this the taco trade, but regardless of the moniker, it's a signal that the administration's stance on tariffs focuses more on negotiating deals to reduce trade barriers and less on the actual implementation of high tariffs to generate more revenue for the government. One risk that I do see to the economic outlook in the second half is that this delay tactic by the administration, while it isn't imposing high levels of tariffs yet, the longer you delay, the longer you see that there's a corporate and capital spending uncertainty. Corporations are desperate for clarity and a greater understanding of the rules of the road.

So until we get more clarity on what the final landing spot for tariffs will be, we could see just a limited amount of some of the pent up demand for capital investment. As for your question on the profit cycle, I'd expect corporate earnings to remain healthy, particularly in sectors that have a greater focus on secular growth opportunities like technology and communication services, or those with a greater domestic footprint that aren't as exposed to tariffs like financials. You think about just those three sectors, they comprise 50% of the market cap of the S&P.

So strength in those areas can offset some tariff-induced margin pressure in some of the more globally oriented import-sensitive sectors like the materials and consumer discretionary sector. Perhaps one last point on tariffs as it relates to the profit cycle. One thing we've learned over the past several months is that across sectors, U.S. companies have shown just a remarkable ability to navigate the challenges posed by tariffs, and many have strategies in place to mitigate the effect of tariffs on their margins by either squeezing their global suppliers or optimizing other parts of their supply chains to take out costs.

And many multinationals have already diversified or relocated supply chains after tariffs were initially imposed on China in 2018 during Trump's first term. And as a last resort, of course, companies can raise prices to offset the impact where they're able to to protect their profit margins, although obviously that could have a negative impact on the economy via the higher inflation feedback loop. So putting tariffs aside for a moment, Jeremy, what do you see as the biggest macro and market risks at this time?

Yeah, it's hard to put tariffs aside, Dan. I mean, I think the biggest risk is that tariff rates are actually at a higher level. But if we do want to put that aside, look, I think that on the downside, I think one of the macro risks that we're monitoring is that debt and deficit finance, debt and deficit dynamics, I should say, are causing the long end of the Treasury bond yield curve to remain high.

So even though the Federal Reserve has cut interest rates by 100 basis points over the past year or so, the 10-year Treasury remains at four and a half, and that's the benchmark rate that many loans are derived off of. And so the cost of capital for many individuals and for small businesses still remains somewhat prohibitive. The other factor, just from a market perspective, is that it's important to be mindful that after the rally that we've seen, equity valuations are high.

The S&P is now trading at 22 times forward earnings. Valuations aren't a good short-term market timing tool. But the average P.E. over the past 20 years has been 16, and 22, the current valuation of the market, is close to the highest valuation level we've seen over that two-decade time period.

So a 5% to 10% correction just to work off some of the valuation excess could always pose a short-term tactical risk. I would say when I'm asked about risks, I like to think about two-way risks, right? So it's not just about downside risks.

I think there's upside risks as well. Investors continue—I would say the biggest upside risk is that investors continue to underestimate the resiliency and adaptability of the U.S. economy. If we can avoid a meaningful economic drag from cash, frankly, underlying fundamentals of the U.S. economy are fairly healthy.

Consumer and corporate balance sheets are strong. There's no obvious areas of overheating. In fact, as I mentioned, segments of the U.S. economy like housing and industrial activity should see pent-up demand unleashed, considering both of those areas have been in a two-year slump or so.

And the momentum in the labor market continues to be solid. And when Americans have jobs, they tend to spend. So consumer spending really isn't threatened unless we really start to see more significant cracks in the labor market.

I would say the other upside risk is that we finally do get that normalization of interest rate policy. The Fed has been on hold for a few quarters after cutting interest rates by 100 basis points. Currently, the Fed funds rate is four and a quarter to four and a half percent.

So if we indeed get another 100 or 150 basis points of rate cuts over the next year, year and a half, that should support a recovery in those interest rate sensitive parts of the economy, like housing and autos and more broadly, corporate capex, which has been flourished in part due to the high cost of capital. If we move over to thematics, I know the UBS chief investment office and your team, Jeremy, have been very constructive on artificial intelligence, AI, as a market theme for some time now. Is that still the case and what signposts are you watching as it relates to AI?

The short answer is yes, we're bullish on AI and continue to believe that AI will prove to be a transformational technology that will deliver productivity gains across the entire global economy over the next five to 10 years. And I think the important point of AI today is that we are still, as an investor, is that we are still in the very early inning of a multi-year, likely multi-trillion dollar AI infrastructure build out. And despite the volatility that we saw in AI related stocks earlier this year, actual company results from the largest incumbents driving the AI theme continues to show healthy momentum and no signs of slowdown.

So, for example, in May, the world's largest semiconductor company and the leading manufacturer of GPUs and AI factories delivered very strong first quarter results and guided to second quarter revenues well above street consensus. If we're looking ahead for signposts, the signposts that we're closely monitoring, I would say there's a few of them. First we're watching for advances in the underlying technology, specifically generative AI model performance, which comprises the raw compute power of the semiconductors and the capabilities of the underlying algorithms and frontier models that power a lot of the current AI capabilities and create new AI use cases.

Second, what the market is hyper focused on is capital spending from the large hyperscalers as a leading indicator to those capabilities. Now, in 2025, capital spending from the four largest hyperscalers is expected to exceed $300 billion, up from roughly $200 billion in 2024. And the leaders of these companies continue to appear very committed to expanding CapEx on AI capabilities and infrastructure, not just for 2025, but over the next several years, in part because they see the demand signals that justify the spending, and in part because many of them have stated that under investing in AI would be a potential existential threat to their companies.

And just yesterday, we heard from one of those hyperscalers that took up their CapEx figure for the year by $10 billion. We also have to consider and monitor the physical power load that's required to run those data centers and AI applications. So we're tracking order growth for industrial and utility companies that supply the electrical equipment and power, or assign posts to monitor and track progress of the AI team, and similarly results from some of those companies so far in earnings season that's been encouraging.

And perhaps lastly, another important factor to monitor as a science source is simply the adoption rate of AI applications, especially by businesses. So far, what we've seen is that there's been a high adoption rate of AI applications by consumers using chat GPT, perplexity, other large language models. But increasingly, we're seeing more promising signs of greater AI penetration by U.S. businesses.

And there's a survey that's by the Census Bureau that shows the percentage of companies that have used AI or that expect to use AI over the next six months. And that data set has been steadily rising. So putting it all together, Dan, we're bullish on AI, recognizing it won't be a straight line for the stocks.

There's always volatility around paradigm shifts. But the underlying technological advances we think will be transformative, and there's still a long runway for strong earnings growth for the stocks in the AI infrastructure layer, application layer, power and resources layer that ultimately are going to benefit. So outside of AI, where are you and your team finding the most attractive opportunities within U.S. equity markets right now?

Start with, I mean, given the current market environment of high policy uncertainty around tariffs and the above average valuations that I mentioned, I think it's important to be diversified here, to have exposure to both secular growth opportunities, but also cyclical and defensive areas of the market and avoid over concentration or extreme portfolio tilts in the current environment. So within the more cyclical market segment, we continue to lean into the financial sector. We've been bullish there for much of the last two years.

Unlike other manufacturing sectors, there's no direct tariff risk for financials since they provide a service and don't import goods. And second, while the market's trading at 22 times earnings, financials are trading at a more reasonable 17 times earnings or in line with their historical discount to the market, despite the fact that fundamentals look very attractive. If you look at the core fundamentals for financials, you have interest rates which are supportive for net interest margins.

You have a loan growth that's picking up. You have pent up demand for capital market activity. And most importantly, you have a regulatory backdrop, which should be improving over the next few months and likely over the next few years.

I would say that investing in defensives right now is a little trickier than normal. The reason I say that is that the traditional defensive playbook for investors is to focus on stocks in non-economically sensitive sectors such as health care, consumer staples and utilities. But all of those sectors have some idiosyncratic challenges in the current cycle.

Like we start with health care, pharmaceutical companies make up about half of the market cap of the health care sector and policy uncertainty around drug price reforms add risk to that traditional safe haven of the market. Higher interest rates have posed a risk and a headwind for the utility sector since most utility investors seek higher dividends and bonds offer attractive alternatives and tariff risks are high for consumer staple companies as well as consumer staples. The sector's exposure to the lower income consumer, which has been particularly stressed in the current economic cycle, is above average.

And so, you know, what we've been focusing on and looking for are specific industries across all sectors that look more insulated from some of those headwinds I just mentioned. So that results in us focusing defensively in areas such as medical device companies within health care, wireless towers within real estate, insurance companies within financial and waste management companies within industrial. Well, Jeremy, great speaking with you today and thank you for spending some time with their listeners and clients to share with them your thoughts on the equity markets, the macro environment, risk considerations, and of course, an update on the house view equity portfolios.

Thank you again for joining us. Yep. Thanks for having me on again.

Thank you for tuning in. Be sure to visit UBS dot com slash studios to view the entire UBS studios suite of podcast channels, along with our video offerings such as UBS Trending. You can also follow us on Instagram for content highlights at UBS Trending.

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House Call: Talking Equity Markets with UBS Asset Management

What the desk is arguing

Sources & References

Primary source