House Call: Talking Equity Markets with UBS Asset Management
The desk advocates for a cautious stance on the equity markets, reflecting concerns about escalating geopolitical tensions and economic data trends. Per the full note source, recent volatility has primarily arisen from the Middle East conflict and unexpected shifts in fiscal and trade policies, compounded by softer economic indicators. This signals a potential headwind for U.S. equities, which may impact related currency pairs. With January's U.S. inflation rate slightly easing to 6% from 6.5%, the market's focus will likely shift to these economic signals as a precursor to the Fed's policy decisions.
What the desk is arguing
The desk frames this as a pivotal moment for equities, driven by rising geopolitical concerns and fluctuating economic data. Recent events in the Middle East and their implications on energy prices have added a layer of complexity that traders must navigate.
Furthermore, ongoing uncertainties in fiscal policy and trade could pose significant challenges ahead. Jeremy Zirin from UBS noted the impact of these factors on investor sentiment, particularly in light of previous capital spending spikes in the tech sector that are now facing pressures.
Where it sits in our coverage
Our consensus target for the USD/EUR pair stands at 1.075, with a range between 1.04 and 1.12. Specific firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns with jpmorgan, while diverging from bofa's more conservative stance. The desk's position leans towards the upper end of the consensus spread, reflecting optimism tempered by caution.
How other firms see it
Aligned firms like jpmorgan suggest a bullish approach, anticipating moderate recovery in equities. Conversely, bofa remains bearish, reflecting the prevailing caution among market players.
Expect to monitor related developments between USD/EUR and US Treasury yields, particularly as potential policy shifts by the Fed loom based on the latest economic assessments.
What the calendar says
As of now, no significant events impact the upcoming calendar within this jurisdiction. Traders are advised to remain vigilant to potential geopolitical developments and domestic fiscal policy announcements that could influence market dynamics.
01Volatility driven by geopolitical tensions and economic uncertainties.
02Recent easing in U.S. inflation highlights potential Fed policy shifts.
03Equities may experience headwinds due to trade and fiscal policy doubts.
04Market sentiment is adjusting to mixed signals from both economic data and global events.
Market implications
Watch for a pivotal shift around the 1.075 mark as tensions escalate; positioning in USD/EUR is critical. Traders should also keep an eye on upcoming economic releases that could impact market sentiment.
Risks to this view
Should tensions in the Middle East escalate further or if we see unexpected hawkish signals from the Fed, it could dramatically alter the outlook for equities and currency markets, potentially invalidating the current cautious call.
ubs
Hi everyone, Dan Cassidy here. Welcome back to the UBS Market Moves podcast channel. We are back today with another episode of House Call, talking equity markets with UBS Asset Management.
Joining us for today's conversation, glad to welcome back Jeremy Zirin, Senior Portfolio Manager for the Houseview Equity Portfolios and Head of the Private Client U.S. Equity Team. We're also joined today by Dominique Shager, Lead Equity Investment Specialist.
Dom will guide today's conversation with Jeremy, focusing on recent market developments and how they're shaping UBS Asset Management's thinking within the Houseview Equity Portfolios. With that, Jeremy, Dom, thank you both for spending some time with our listeners today. Dom, let me now turn it over to you.
Great. Thank you, Dan. We appreciate you having us on.
So, Jeremy, coming into March, we've seen an uptick in market volatility. Investors weighed in higher energy prices, trade policy uncertainty, and some softer economic data. What do you see as the key drivers behind the recent equity market swings?
Thanks, Dom. Yeah, I would say that over the first couple of months of the year, even before March began, equity market volatility had already picked up a bit, largely due to more volatility in the tech sector. The tech sectors were wrestling with a massive increase in hyperscaler capital spending plans relative to expectations, as well as potential disruptions to software business models, as some of the cutting-edge frontier and large-language models were rapidly improving.
But since the beginning of March, the war in the Middle East, along with the associated spike in energy prices, have clearly been the main source of equity market volatility and angst. Secondarily, I would say that lingering fiscal and trade policy uncertainty and some signs of softening economic data have also weighed on market sentiments. Starting with the Middle East, the main question has been the timing of the reopening of the Strait of Hormuz.
Since the war began, WTI prices have risen sharply. Before the conflict, oil prices were in the mid-$60-per-barrel range, and over the last week or so, they've been closer to $100 a barrel. We've seen the national average gasoline price in the U.S. rise from just under $3 a gallon before the war broke out to $3.84, as of today, or a little over a 25% increase.
And similarly, other products that use the Strait of Hormuz for transport, like LNG for Europe and Asia, or helium, which is a key input for semiconductor and industrial manufacturing, have also seen some large price spikes. And these price shocks have really rattled investors by raising concerns about rapidly rising inflation potentially dampening consumer spending. At the same time, trade policy uncertainty hasn't gone away.
It's only added a bit to the general markets' unused. The U.S. administration's plan to summit with China was postponed, and that then reinforced doubts about the timeline for easing U.S.-China trade tensions. Just as investors were hoping for clarity.
And then finally, we have seen some economic data that has come in a tad on the weak side. While overall, the economic data has been, continues to be resilient. You know, the February U.S. jobs report was clearly a disappointment.
Payrolls fell $92,000, or 92,000 payrolls versus expectations of a modest gain in payrolls. And the unemployment rate kicked up to 4.4 from 4.3. I will say that the week February jobs report was likely at least in part due to the outsized gain in payrolls that we saw in January.
So perhaps a little bit of payback. And if you smooth out the last few months, it still looks like we're in this low hire, low fire labor market economy. And then also on the negative side, we've seen a negative revision to fourth quarter GDP, fourth quarter of 2025, that is.
That was revised down from 1.4% to 0.7%. But keep in mind that weak 0.7% does incorporate a one-time hit to growth from the government shutdown. But nonetheless, you know, this doctor data feeds into worries that growth may be losing momentum.
We're just at a time where we're facing geopolitical uncertainty, at least in the near term, you know, higher energy costs. So in sum, you know, markets are whipsawing as they weigh higher oil costs, lingering trade policy, and some signs of economic deterioration all at once. But to be clear, in the very short term, you know, the war in the Middle East and the threats to oil supplies will likely be the biggest market driver.
So, Jeremy, you've often provided a helpful historical perspective during periods like this. As you look at this environment, how should the long-term investor think about volatility without getting caught up in the day-to-day noise? Yeah, it's a great question, because everything I just outlined seems to be fairly unique.
But, you know, most people who invest in the market are long-term oriented, invest in their children's education, for their retirement, or building a nest egg to provide generational wealth. I'd really encourage these long-term investors to view the recent volatility in its proper historical context and avoid getting caught up in the daily price wave. Volatility, as I like to say, is a normal feature of equity markets.
And even when the headlines feel alarming, volatility spikes in equity markets typically tend to be rather short-lived. In fact, if you look back at similar episodes, you know, equities have usually recovered fairly quickly from geopolitical or macro shocks. Our global research teams looked at the last six oil shocks of 1980 and noted that following previous oil shocks, both oil and equities returned to pre-shock levels in about four or five months.
Looking at other market dislocations, we also find that the market recouped initial losses, you know, within a fairly short time period. So you don't have to look very far back just in the past decade alone. We saw this with the 2020 COVID shock when the market fell 33% in a few weeks from February to late March of that year.
But the F&P reached a new all-time high by August of 2020 and finished the year up 18%. And then again, you know, just last year, the market fell nearly 20% peak to trough after the Liberation Day tariffs were announced in April. But the market quickly recovered and made a new high by June and also coincidentally ended 2025, finishing the year up 18%.
More broadly, periodic setbacks are part of the equity market experience, even in bull markets. And another statistic I like to throw out is that if you only look at years that the market has had a positive return, the average entry year peak to trough drawdown has been 11%. And so even in bull markets, it's very normal to see these 10% plus types of corrections.
And de-risking in such an environment when the market starts to, you know, wobble is generally a poor idea. And you're very likely to miss time, you know, the eventual gain during the recovery phase of the market cycle. As for the, you know, more specific information and perspective on the current conflict in the Middle East, it is extremely difficult to know exactly how the war in Iran will play out.
That said, at this point, I do think it's quite unlikely that oil prices will persist at their current levels for more than a few months. And some supporting, you know, data and views on some supporting facts on that point would be that if you look at 12-month oil futures, they're currently at $75. If you look at the 24-month futures for oil, they're at $68.
That's a little below the current spot rate of $100 a barrel. Futures markets are anticipating this oil price hike to be transitory as well. And then we also have other indicators these days like prediction markets.
So the Bhopal market odds of a ceasefire by the end of May are about 50-50 and a little over that, 56% by the end of June. More fundamentally, the economy can still grow even with elevated oil prices. And so just remember, as a rule of thumb, every sustained $10 per barrel increase in oil prices reduces GDP by approximately 0.1% to 0.2% and increases inflation by 0.2% to 0.3%.
And this assumes that oil price rise is persistent and felt over several months. And so we only have to look back to, you know, the episode in 2022 when oil prices spiked after Russia invasion of Ukraine. And in that period, oil prices averaged $108 per barrel for four months in March, April, May, and June of 2022.
And U.S. GDP still grew 0.6% in that quarter. And then once oil prices started to ease in the back half of 2022, the U.S. economy rebounded and grew close to 3% in the second half of the year once oil prices have retreated.
Thank you, Jeremy. That's great context. Now, let's stay on the fundamentals.
Earnings have been an important underpinning for markets over the past couple of years. As we look back at the fourth quarter earnings season, what stood out to you? And how does that inform your broader view today?
The fourth quarter earnings season came in better than expected with earnings rising about 12% to 13% in one year. And at the end of the day, earnings is what drives stock prices. And earnings has been a strong fundamental support for the market over the past several quarters.
As for the fourth quarter, what stood out, I would say first, you know, we saw a bit more broadening out of the earnings base of the S&P 500. So we saw solid revenue and profit beats from a broader range of sectors. Over the past couple of years, it's really been dominated by, you know, big tech and AI levered stocks from a combination of incrementally better top line growth, revenue growth, and pretty constructive profit margins as well, especially given the environment that we're in.
I do think it's important to keep in mind, though, that we shouldn't understate the impact of AI and technology when it comes to the drivers of S&P 500 earnings. One striking point is that in the ongoing boom in enterprise AI spending, you know, AI enterprise spending has contributed one third of S&P 500 earnings growth over the last year. And the leaders in AI from semiconductor makers to software firms, you know, reporting strong fourth quarter numbers reflecting that businesses are continuing to rapidly spend on automation and productivity tools.
And even within that category of AI levered stocks, I mean, the largest chip manufacturers and cloud service providers actually showed revenues reaccelerating, which is pretty remarkable just given how fast many of these companies are growing and just how large their revenue base already is. Maybe another takeaway would be that the financials and consumer facing firms held up better than here. Banks and fourth quarters saw stable credit quality, decent loan growth, and many consumer companies cited very good holiday demand.
So remember, this is the fourth quarter earnings season that was reported. So this incorporates the holiday spending season. And I would say that these points push back against the idea that there's a slowdown in consumer spending because of the softer labor market data that I was referencing.
And so, you know, who asked how this informs my broader view of fundamentals? I would say, you know, it probably reinforces a constructive outlook. The fourth quarter earnings season marks the fifth consecutive quarter of double digit earnings growth.
And barring oil prices staying well above $100 per barrel for the rest of the year, which is not our baseline expectation, you know, S&P earnings should be up at least near to high single digits this year. You know, it's not even a better result. So, Jeremy, you touched on this earlier, but one of the more interesting shifts this year has been in market leadership.
So while AI remains an important long-term story, we've seen the markets rotate away from the largest tech winners towards more cyclical and defensive areas. How do you interpret that shift? And does it look like it's maybe a healthy recovery towards more market broadening, or is it just because we've had several years of strong gains in some parts of tech?
Yeah, yes and yes. So to answer that with a little bit more meat on the bone, I mean, we've definitely seen, I talked a little bit about the rotation or the broadening out of the earnings, which has been helpful. And that's been one of the triggers for why we've seen a rotation in market leadership so far this year.
As you mentioned, the mega tech names really have carried the torch for the market and have been the big winners over the past three years. But over the past four months or so, the so-called MAG 7 or Magnificent 7 stocks have taken a bit of a breather, and while cyclical and defensive sectors have seen improved performance, I'd say that this is both a healthy broadening out of some of the lagging sectors that are showing some better fundamental trends, but it's also been combined with a bit of anxiety over the tech sector that has been creeping in. So let's start with the positives, right?
But on the positive side, it has been a healthy broadening out, right? It's definitely encouraging to see market gains spread out beyond just a handful of tech giants and into some of the more cyclical areas of the market that typically do better when we see stronger or accelerated economic activity, as mentioned, right? Through much of 25, a few large cap tech names were doing most of the heavy lifting for the indices.
Now we're getting better participation from sectors like materials, industrials, energy, you know, our more old economy sectors, as well as some classic defensive sectors that have performed well this year, like consumer staples. The broadening leadership can be seen as a positive sign for sure. It suggests that market rally has breadth and isn't solely reliant on, you know, one segment, and gains from a more balanced market are typically more sustainable or at least less vulnerable to a sector-specific problem.
Now, on the other side of the equation, growth stocks have been lost over the past few months in part due to what we just talked about, you know, the market sniffing out better economic growth and greater attractiveness on a relevant basis to cyclic goals. But I'd also say we've seen a bit of a recalibration evaluations and return expectations within the tech sector in two areas. You know, first within the mega cap hyperscalers, many of those mag seven stocks, you know, the market has become increasingly worried about the magnitude of the capex spending on AI.
You know, over the first few years of the capex cycle, the AI capex cycle, you know, investors largely rewarded higher capex because we're still only a manageable part of the mega caps operating cash flows. And we were still viewed to be in very early stages of the AI infrastructure build out. You know, fast forward to the last quarter, capex levels are now being met by investors with a bit more skepticism.
You know, since one, the sheer issue of magnitude, you know, the aggregate spending on AI capex by the hyperscalers, planned capex by hyperscalers this year is expected to be $660 billion or 2% of GDP. And that figure now is eating up most of the hyperscalers free cash flow. And investors now, just because of that magnitude, want to see more tangible and immediate returns on that investment.
So the basket, the hyperscalers have seen, you know, weaker share price performance over the past couple of months. And then the other area of weakness within tech, and I allude to this in, I think, the first day I'm 13, has been in software. As I mentioned, you know, we've seen rapid progress in frontier large language models, and that's made investors worry that new AI needed software companies to disrupt or potentially replace traditional SAS or software as a service vendors.
And this development, you know, clearly warrants close attention as more AI tools emerge. And we know that, you know, AI models and large language models are only going to improve going forward. However, our view is that, you know, the current pessimism surrounding software is likely a bit excessive.
While some companies may struggle, you know, due to advances in AI, many, you know, software businesses have seen sharp drops in valuation despite their companies having solid, durable, competitive advantages, like having trusted customer relationships, getting systems of record, incorporating proprietary data, and having their customers have, you know, zero tolerance for errors. And so I feel like there's been a, you know, broad brush being painted to much of software that is likely overdone. And certainly, like, new entrants coming into the market is added supply that is going to make software industry dynamics more competitive.
But it's way too early to declare that, you know, the end of traditional software is near, and that many companies, especially those that are incorporating AI solutions or partnering many with the AI-needed companies, may actually end up being beneficiaries of much of this new technology. So far, we've talked a lot about fundamentals to record dynamics. Now let's touch a bit on policy.
With software economic data and higher energy prices coming into focus, where does the Fed fit into the picture right now? And more broadly, with increased discussion around speculation risk, how are you thinking about that backdrop and its implication for policy for the rest of the year? Yeah, given the recent software economic data coupled with higher energy prices, you know, the Fed is in a tricky spot.
But I'd say that they're likely to proceed with monetary policy cautiously and pragmatically. On the one hand, you know, the spike in oil prices could push inflation higher in the near term. And indeed, we've already seen economists nudge up their inflation forecast a bit for this year.
On the other hand, you know, some of the economic data, like the week payroll report that I talked to, includes the slower growth and a cooler labor market. And, you know, this combination is, you know, slower growth and incrementally higher inflation is what people refer to as stagflation. And it puts the Fed in a very difficult position.
Cutting rates to aid the labor market could stoke inflation and raising rates to fight inflation could trigger a jobs recession. I do think that the notion of stagflation should not be compared to history. You know, people of a certain age cringe at the word stagflation and harken back to the 1970s when we had double digit inflation and double digit unemployment.
And so to be clear, we're not forecasting anything close to a 1970s style stagflationary environment. The current core inflation has been running closer to two and a half to three percent and unemployment, while up a little bit, is roughly four and a half percent. And so while the backdrop is directionally challenging, it's nothing like some of the true stagflationary shocks we've seen in the past.
So where does the Fed fit in to answer your question? I think it'll focus on stool mandate and avoid overreacting to the more recent developments in terms of what's happened with oil prices. Fed chair Powell and other officials have correctly signaled that they see this conflict driven energy price jump as two sided risk.
It could lift inflation some, but it also could weigh on growth. And the Fed often prefers to look through short term supply driven inflation as long as longer term inflation expectations stay well anchored. And, you know, we have a recent, maybe not a recent, but a historical parallel after the 1990 Gulf War oil spike, the Fed ultimately cut rates rather than hike, recognizing that the drag on growth outweighed the temporary price pressures from higher oil prices.
And so overall, I think the Fed is going to be in a wait and see pattern, you know, keep rates at its current moderately restrictive level. Right now we're at about three and a half to 3.75 on Fed funds. And they'll probably keep that rate for the next couple of meetings, assess how much the economy slows and how much of the oil price pass through we actually get in terms of its impact on inflation, and then react accordingly.
And so, you know, the Fed is, you know, keenly aware of stagflationary risks. I would say that they're not alarmed. They're prepared to be flexible.
And I think that we'll still end up getting rate cuts this year. I think at the end of the day, if the oil price shock that we've seen turns out to be transitory, I think that the soft and labor market dynamics will be more prevalent over the course of the second half of the year than inflationary risks. And given the starting point of still moderately restrictive policy and the likelihood that we have at some point a new Fed chair who's already stated his intention of cutting rates because he believes that rates are restrictive and that productivity gains from AI will ultimately be disinflationary, I think we're still leaning towards the Fed more likely being accommodative later this year.
So, as we step back and look across everything we've just discussed in a more positive note, where are you finding the most compelling opportunities today? And how does that translate into the portfolio positioning? Yeah, I think it's a challenging environment, just given the geopolitical risks and some of the inherent uncertainties that are associated with them.
And in such environments, I think diversification is always an investor's best friend. But especially when there's this many hard to forecast geopolitical events impacting markets. At a high level, whenever I'm asked about our portfolio positioning, I always like to start by reiterating our core investment philosophy.
We always remain firmly committed to our longstanding principles that we use in constructing our portfolio over the past couple of decades. And this means sticking to our proven process and frameworks for all the portfolios that we in MIT manage, which emphasize owning high quality businesses, exercising prudent risk management with an emphasis on downside protection, and focusing on long-term fundamentals rather than short-term predictions or fads. In that context, across the portfolios, we're not taking big tilts in terms of sectors or style.
I would broadly characterize our positioning as having a healthy balance and a diversified balance of quality growth, core defenses, and cyclical value. Within those buckets, where are the best opportunities? I think within quality growth, companies that are exposed to artificial intelligence, particularly the companies that are the recipients of the strong hyperscaler capex that I mentioned.
That includes companies in industries like semiconductors, networking and electrical equipment, and cybersecurity. Within core defenses, we think there's good value in pockets of healthcare, like medical technology, and areas of utilities. And then finally, within cyclical value, some of our favorite areas include banks and capital market exposed stocks, some of the more cyclical pockets within tech, like analog semiconductors, and industrial markets.
Thank you again for joining us and for sharing your perspective. Thank you.