House Call: Talking Equity Markets with UBS Asset Management

We are back now with the next installment of our ongoing House Call podcast series with UBS Asset Management, Talking Equity Markets with UBS Asset Management, our first episode for 2026. Joining us as always for the conversation, glad to welcome back Jeremy Zirin, Senior Portfolio Manager of the Houseview Equity Portfolios and Head of the Private Client U.S. Equity Team.

We're also joined today by Dominique Shager, Senior Equity Investment Specialist, again both joining us today from UBS Asset Management. So with that, Jeremy, Don, welcome back. Don, let me now hand it over to you to lead today's conversation with.

Jeremy, welcome back. Thank you, Dan, and Happy New Year to you. Since this is the first call of the year, we thought we'll take a quick look back at 2025 and set the stage for what 2026 may bring.

So with that, let's jump right in. Jeremy, can you kick us off with a recap of 2025 and did the year unfold as you expected or were there any surprises that stood out? Yeah, Happy New Year to you and everyone listening today.

I would say at a market level, there were really three major highlights for the stock market in 2025. First, at a headline level, the bull market in U.S. equities continued and in fact, U.S. stocks delivered a third consecutive year of well above average gains. Over the very long term, U.S. stocks typically averaged about 10% return per year, but last year, the S&P generated a total return of nearly 18% and that was following gains of north of 20% in both 2023 and 2024.

Second, similar to the prior two years, we saw persistent enthusiasm in market leadership from companies that were benefiting from the build out of artificial intelligence or AI. The top two sectors last year in the S&P were the technology sector and the communication services sector, which is dominated by the megacap digital advertising companies that are also building out frontier large language models tied to AI. It shows yet another year of growth stocks outperforming value stocks, but interestingly, the performance gap between growth and value narrowed significantly last year compared to 2023 and 2024.

In 2023, growth outperformed value by over 30 percentage points. In 2024, growth beat value by almost 20 percentage points. Last year in 2025, growth stocks did outperform value once again, but only by about two and a half percentage points with the Russell 1000 growth index up 18.5% and the Russell 1000 value index still delivering solid returns at just under 16%.

So last year was more about growth and value working rather than it just being a growth driven market. And then lastly, I'd say that, you know, in terms of recapping last year, in a change from prior years, global stocks outperformed the U.S. stock market. And some of this was driven by currency, you know, the trade-weighted dollar was down almost 10% last year, but, you know, an index of global stocks ex-U.S. rose by over 30% last year.

So even excluding the currency impact, local non-U.S. markets delivered stronger returns compared to the still strong returns that I talked about in U.S. equity markets. In terms of what went as expected, you know, we did anticipate that spending linked to AI by the so-called hyperscalers or some of the largest U.S. mega cap tech companies would remain strong and be a big macro and market driver, and in fact it did. You know, we saw a continued upside in hyperscaler spending and in a broadening of AI value creation, you know, themes that powered returns across tech, industrial power equipment, and parts of the utility sector.

Overall global AI cap ex grew to over $400 billion last year, and that's up about 80% from 2024 levels. Thinking about what were the biggest surprises last year, I think two stood out, you know, first, you know, while market breadth improved a little bit, I did mention, you know, gross only outperformed value by a couple of percentage points, mega caps still dominated overall index gains across style cohorts. This resulted in the concentration of the S&P 500 narrowing further.

At the end of last year, the top 10 stocks in the S&P 500 represented over 40% of the market value of the index, which is well above levels that we've seen over the last three decades. Another way of measuring market breadth is to see how many companies actually outperform the S&P at any given year, and last year just under 30% of companies beat the index, and I figure within the 20s and 23 and 24, typically you get closer to half of the companies in the index beating the overall benchmark. So just another signal that index gains continue, you know, to be narrow among the biggest companies since they have the largest weights in the index.

From a macro perspective, you know, clearly the biggest surprise was around tariffs. You know, first, the introduction of much higher tariffs was a shock to the market in early April, and ultimately the effective tariff rate paid on U.S. imports rose substantially from, you know, low single digits prior to 2025 to something closer to 15%. But perhaps just as, if not even more surprising to many, was just how resilient the U.S. economy ultimately was considering the tariff shock, and GDP looks to be on track to end 2025 close to up 2%, driven by strong spending from higher income Americans and the strong capex that I talked about on artificial intelligence.

So the bottom line about 2025, as a recap, is that it was a third straight year for stock market gains that were well above average. We've had now cumulative gains over that three-year period of 86%, and so heading into, you know, 2026, we have a very strong market and I would say good economic momentum as well. So Jeremy, as you mentioned, equity markets showed notable resilience last year.

What were some of the key drivers? Yeah, if I could summarize last year's market drivers in a single sentence, I'd say that stock market gains in 2025 were largely earnings-driven and innovation-led, with policy volatility acting more of a speed bump rather than a showstopper. So if we unpack each of those issues a little bit more on earnings, and I think the earnings are on track to be up like 10% to 12% for 2025, depending how, you know, fourth quarter results come in.

And so the bulk of the S&P price gain last year was supported by profits rather than multiple expansion. On innovation, you know, we just talked a bit about how much the hyperscalers are spending on AI, and that's translating into strong earnings growth for many AI infrastructure companies, but it's also boosting economic growth and raising overall levels of economic productivity. You know, how much of this is, you know, early dividends from on productivity gains from AI is unclear, but productivity has averaged about 2% over the past 30 years.

And in the second and third quarter of last year, it's run between 4% and 5%. And that's a clear positive for corporate profit margins and thus by extension for equity markets as well. And then in terms of policy, you know, one policy that was an incremental positive and a driver last year was the Fed.

The Fed shifted their monetary policy stance from restricted territory to something closer to neutral, which had the effect of improving equity risk reward by compressing discount rates across duration-sensitive assets like stocks and reducing the cost of capital for capital investments for corporates. So Jeremy, staying on the Fed, what did the Fed's actions and messaging last year tell us about the path ahead? And how should investors interpret policy direction coming into 2026?

First, let's talk about where we are in the Fed's rate-setting cycle. In late 2024, the Fed cut rates by 100 basis points from the peak of 5.25 to 5.5%, which is 4.25% to 4.25%, 4.5%. But last year, inflation data remained stubbornly high at the beginning of the year.

And then in April, the introduction of tariff uncertainty led the Fed to just pause its rate-cutting cycle. And they did that all the way to September of last year. Then in the last four months of last year, the Fed cut interest rates 75 basis points, ending the year at a target rate of 3.5% to 3.75%, which is within the range, albeit likely a little bit on the higher end of the range of what most economists believe is neutral monetary policy.

So to answer your question, what's the setup for the Fed in 2026? The Fed's preferred gauge of inflation, the PCE index, still sits at 2.8%, and that's well above the Fed's 2% target. And the Fed lowered rates last year because the other side of its mandate, maximizing employment, was starting to weaken.

And the Fed described its approach in lowering rates from restrictive territory to more neutral territory as an exercise in risk management. But now that we're at neutral territory, and recent labor market data has been more consistent with a low-hire, low-spire economy, not economy that's rolling over, it looks like the Fed may be on hold for a little bit of a time. I would say that they still have an easing bias and that rate cuts may come later in the year.

But at least for now, we're likely to see a pause in the rate-cutting cycle over the next couple of meetings until we see a steady slowdown in inflation, or unless labor markets do, in fact, weaken much more than our expectations. The wildcard here is that President Trump will be nominating a new chair of the Federal Reserve very shortly to replace current Fed Chair Jay Powell, whose term ends on May 15th. And the current list of candidates include former Fed Governor Kevin Warsh, current Fed Governor Christopher Waller, Kevin Hassett, who's Trump's lead economic advisor, and Rick Reader, the global head of fixed income at BlackRock.

The key issue here for markets is Fed independence, which the markets use as sacrosanct. In my view, all four of the candidates that I just listed would act independently and support the checks and balances that come along with Fed independence. That could get tested by markets, though, certainly, especially in the early stages of a new Fed chair.

So overall, you know, our expectations, as things stand right now, is that the Fed will end up cutting once or twice this year as inflation starts to, you know, have more clearer signs of normalizing, i.e. moving closer to 2%. But the first cut this year probably isn't coming until sometime in the spring, or perhaps even as late as the summer, considering it may take a little bit more time for inflation to clearly be trending towards 2%. Thank you, Jeremy.

So changing gears for a bit, last week, major banks kicked off the latest earnings season cycle. But we're still very early. Any insights or thoughts on what we can expect from this earnings season?

Heading into earnings season, I've been expecting this to be another good quarter for the S&P market. You know, earnings per share growing in the low teens, 10 to 14% range, year on year. And that would represent the fifth consecutive quarter of double-digit EPS growth.

And that's consistent and supportive with the view that I just expressed earlier that profits and not valuation multiples are driving this stage of the bull market. And as you mentioned, Dom, it's still very early in earnings season. We've only had roughly 49 of the 500 S&P 500 companies, so a little under 10%.

But I'll make two observations of what I've seen so far in earnings season. One is that results from banks and some tech and industrial companies have generally been consistent with what we've seen over the past three or four quarters. For banks, fundamentals remain very solid.

We're seeing continued pickup in capital market activity, and most bank management teams believe that we're still in the early innings of that recovery. Banks have particularly good insight on consumer spending trends, and most are saying that overall spending levels remain resilient. And then finally, we're not seeing any worrying signs related to consumer credit, but delinquency and charge-off levels remain quite low.

In the tech sector, the world's largest semiconductor manufacturer reported very strong results and took up their 2026 full-year guidance for capital spending. There's been a lot of talk and concern about AI potentially being in a bubble and that the hyperscalers have already spent too much, but results in the outlook for spending from the leading foundry in the world is a clear sign of confidence in durable AI-driven demand. The company also made comments that from their lens, demand for semiconductors will continue to outstrip supply for at least the next two years.

And so overall, while there is a lot of concern about AI potentially being in a bubble, it doesn't appear that the spending from the hyperscalers is going to abate any time soon, and that most companies still are signaling that there is no supply gap, that there is ample demand for their products and services, and that appears likely to continue, at least according to many of the companies that we've spoken to or heard from already in earnings season. And then my second observation is more market-related, is that the market, at least so far, and again, very early in earnings season, but the market so far hasn't really been rewarding some of the strong early reports from the so-called early reporters during earnings season, at least not to the same extent that we've seen in past quarters. Now, this could be due to higher valuations, which bring about higher expectations, but at least in the case for financials, it's more likely related to a recently introduced policy uncertainty.

You know, going into the year, financials were viewed as a clear beneficiary of deregulatory industry policies, and we still think that should remain the case over the next couple of years, but the administration's recent proposal of a 10% cap on credit card interest rates, even if it's unlikely to be implemented, has placed a bit of an overhang on many financial sector stocks, which may not be lifted until there's a bit more policy clarity. Okay, to close us off, Jeremy, one of my favorite questions I ask every year is, looking into your Ethereum crystal ball, what's ahead for 2026? What's your base case scenario, and what could change that outlook?

Yeah, I'm still waiting for you to send me that crystal ball, but the big picture is that markets in 2026 should be framed by a couple of big investment debates. The first is around AI. My base case, as I just indicated, is that we'll see continued strong spending from the hyperscalers and continued steady consumer and corporate adoption of AI applications and services that, in turn, should drive strong earnings results for many AI enablers and AI adopters.

The second big market debate is whether or not we will see a broadening out of market returns this year after such narrow leadership over the last three years. I actually think this broadening out process started late last year, when the Fed started to cut rates, economic growth remained solid, and investors started to anticipate an improved earnings outlook for a broader set of sectors and companies. It's important to recognize that market leadership has been narrow over the past three years, with tech companies leading the path, largely because those companies have been delivering the bulk of the market's earnings growth.

If that earnings growth differential between the megatech, tech, and AI leveraged stocks and the rest of the market narrows, we should see a broadening out of market gains. Our base case is that tech and AI still does fairly well this year, but it won't be the only sector that does well and that returns across the market will be a bit more uniform. To answer your question about what could change our thinking or change the path here, I would put it into three categories.

First, if AI disappoints. If companies don't show clear and monetizable benefits from AI, valuation multiples in AI-heavy sectors of the market clearly have room to compress. The second one would be on the broadening out trade.

If inflation continues to be sticky, or we see energy shocks that force the Fed to slow or pause cuts for an extended period of time, or worse yet, cause the Fed to reverse course and start to raise rates again, that would clearly be a negative for the markets overall, but more specifically for value-oriented equities and for that broadening out trade. And then lastly, I would say sustained policy uncertainty also has the ability to weaken any recovery in the more traditional, non-AI component of the corporate spending cycle. And so while Greenland is in the headlines today, if the administration is also trying to tackle the affordability problem through various policy measures, and if there's limited clarity on the implementation or the effectiveness of some of these policies, that can also limit or curtail the broadening out trade.

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