House Call: Talking Equity Markets with UBS Asset Management
The desk observes that US equities have rebounded sharply from their recent lows, signaling renewed investor confidence amidst easing trade tensions, particularly with China. Per the full note source, Jeff Hans from UBS Asset Management highlights that the market has witnessed a remarkable transition from a 19% decline to a subsequent 20% rally, largely driven by optimism surrounding tariffs and the resilience of corporate earnings. This aligns with broader market sentiment suggesting a potential stabilization phase in equities, although ongoing volatility remains a concern. The desk's view posits that this rally might not be sustained without strong economic indicators to support it.
What the desk is arguing
The desk argues that the recent rally in US equities points to a potential stabilization, contingent on broader economic indicators. As mentioned by Hans, the pivotal reduction in tariff fears has played a significant role in this recovery, paired with a sharp decline in the VIX, which is now below 25 from pandemic levels of 50.
Supporting this thesis is the observation that corporate earnings have yet to exhibit the anticipated negative impact from economic slowdowns, helping to buoy investor sentiment. The dynamic shift reflects not just technical recovery, but a return of confidence in the equity market's ability to weather macroeconomic turbulence.
Where it sits in our coverage
Our consensus target for the equities market is projected at a range of 1.075 (1.04 - 1.12), with various firms offering insights into their targets. Notably, we have: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns with jpmorgan, which holds a more aggressive target within the upper range of our consensus, while bofa adopts a more cautious stance at the lower end of the spectrum.
How other firms see it
Several firms like jpmorgan and goldmansachs align with the desk's optimistic sentiment on equities, pointing towards a potential continuation of the recovery trend. In contrast, bofa positions itself more conservatively, reflecting concerns over economic fundamentals that may hinder sustained growth.
Key indicators to watch include the trajectory of USD/JPY and the ongoing adjustments in Federal Reserve policy, as these elements will have profound impacts on equity valuations and risk appetite going forward.
01US equities have staged a notable recovery, reversing a significant decline.
02Investor confidence is buoyed by easing trade tensions and resilient corporate earnings.
03The volatility index (VIX) has decreased to levels indicating reduced market fear.
04The sustainability of the rally will depend on forthcoming economic indicators.
Market implications
Traders should monitor the VIX levels for signs of increased volatility, particularly if they rise towards the previous highs. Watch also for economic reports that might impact the Federal Reserve's stance on interest rates, as these could influence both equity valuations and currency markets.
Risks to this view
A reversal of the current bullish trends could occur if economic data reveals weakening fundamentals, which would likely prompt a reevaluation of corporate earnings expectations. Additionally, renewed tensions in trade relations could undermine investor confidence, leading to a sharp decline in equities.
ubs
Good day UBS, Dan Cassidy here. As we have been highlighting, we are back now with the next installment of our ongoing house call series with our partners from UBS Asset Management, where we do talk about equity markets. Joining us for this month, glad to welcome back Jeff Hans, Jeff is lead portfolio manager for the Opportunistic Equity Income and Mid-Cap Portfolios, joining us today from UBS Asset Management.
Jeff, nice to be on with you and thank you for dropping by to spend some time today with our financial advisors. I know there's a lot going on within equities at the moment, so let's dive right into it, acknowledging how the market has of course had a strong rally over the past two months, so I'm curious from your vantage point, where do we go from here? Thanks for having me on, Dan, I always enjoy speaking with our advisors.
We've gone through this period of just incredible market volatility in such a short period of time. We had about a 19% peak to trough decline with markets bottomed in early April, subsequent to that we've seen a 20% rally when things were at its scariest in the early part of April, the VIX got as high as 50, which is a level that's consistent with peak COVID and GFC levels, and since then it's actually been more than cut in half, so really extraordinary stuff in just a span of a three, four month period. I think people are pretty keenly aware of what drove the initial pullback, pretty obvious, but when we sort of think about the rally, let's quickly touch upon that before giving our thought process as we look ahead.
I think behind the rally there's a couple things. One, there seems to be an off-ramp to tariffs, as the president had discussed, deals were being negotiated, then obviously there was a pause in reciprocals and a cut to the tariff rate and pause with China, and I think that certainly got investors excited. Then the second part was we really have yet to see any negative impact to corporations.
First quarter earnings season was fairly solid, guidance was upbeat, I think there were some expectations going into first quarter earnings season that we could see some pretty severe cuts to guidance or companies might withhold guidance, actually, and we didn't really see any of that play out, and so as we sort of think, coming back to your question of where do we go from here, our base case view at this point is that moving ahead there's still uncertainty, but we now think the market has moved from a recession scenario back in early April to one that's viewed as more of this wall of worry. I would tell you that in the latter scenario, we tend to see pockets of market volatility and we expect that to probably be the case, but broadly speaking, markets tend to grind higher through those wall of worry events, and so I'd say we do think there's a risk to economic growth and we've seen some recent signs of that, and we think we could be in store for some softening growth trends in the back half of the year, not recessionary but just a slowdown should tariffs go into effect, but we think it's manageable, and our thought is that any resulting market weakness is likely to be bought. Let me just touch on two big reasons why we're optimistic, and first I kind of touched on this earlier, but the Trump put is alive and well.
I said that he had paused reciprocals by 90 days really after a period of a spike in bond yields and pretty big move up in the VIX or stock market volatility, and then you had the cut in China tariffs, that came on the heels of meetings with some major retailers who were telling the president that retail shelves would be out of stock and that a tsunami of price increases would be coming for the consumer, and so our thought process is that if markets continue to respond negatively to any period of slower growth as it relates to tariffs, we think that there would likely be additional tariff removals or pauses, so that Trump put we continue to think is alive and well, and we think that does provide somewhat of a floor in the markets. The second big positive is this coming period of what we expect to be deregulation, which the administration and the Treasury Secretary have openly talked about now for several months. There's really two-fold benefit here.
One is to small and mid-sized businesses, and the other is to the financial industry. On small and mid-sized businesses, they're really the lifeblood of the economy. These owners or these businesses account for about 80% of the employment in the U.S., and if you go back to Trump 1.0 and his first administration, and then really prior to his recent election, one of the biggest hangups you would heard from these SMBs, from these small and mid-sized business owners, was how a tougher regulatory backdrop had been a hindrance to growth historically, and so our thought is that as the administration seeks to reduce red tape and cut out waste, we think it drives improvement in confidence in this cohort, which we think can trickle through into some better economic activity ahead.
On the financial piece of this, our view is that we anticipate this relaxation of bank capital requirements, much less regulatory oversight as well, which we think leads to reduced costs. We think it frees up more time for bank execs to run their business, and in addition, we'd expect a more favorable backdrop for M&A activity from the FTC, given some pretty big changes in leadership at that agency. Similar to SMBs, obviously the banks are critical to our economy, and so less capital, less costs, more time on executive hands to drive business, we think does, or has the potential to trickle through into increased loan activity, for example, reducing costs for consumers, which we think does have an economic benefit.
So looking out over the next six to 12 months, I'd say our view is constructive for the markets, and while we think that there could be this period of increased volatility, driven from any macro softness, we think that would likely be somewhat short-lived. Well, Jeff, thank you for sharing that assessment and outlook to single out growth stocks, in particular, performing very well of late, sharply beating value in the current quarter. How are you, Jeff, thinking about the outlook between growth and value ahead?
Growth stocks have had this remarkable rally just this quarter, right, and the quarter's not a week or so away from being over, as it relates to value stocks. So just to sort of frame it for you, quarter-to-date growth stocks have beaten value by about 12%. If you look at the valuation spread today, growth trades at about a 75% premium on a relative P.E. basis.
If you go back over the last 30 years, growth tends to trade at closer to a 48% premium. So growth today certainly looking pricey, for sure. That said, the biggest catalyst that we've seen for the recent growth stock outperformance has been this continued trend of strong earnings growth, and that seems to be a continuation of what we saw in 2023 and 2024, when growth stocks also sharply outperformed value.
If you just go back to those two years, the MAG-7 stocks, which we'll use as sort of a proxy for growth, earnings in that cohort were up about 36% in 2023 and 2024. If you look at the rest of the S&P, so the S&P 493, earnings were basically flattish over that two-year period. And as we know, the direction of earnings growth, as it goes, so goes stock prices.
And so we think that was the biggest driver of the narrow market performance we saw during that period. Fast forward to today, or the first quarter earnings season, many of the mega cap tech names, particularly those with AI exposure, had pretty solid quarterly results, and the outlooks were fairly robust, especially as it relates to expectations for increased CapEx over the coming years. Meanwhile, if you sort of look at more of the cyclical areas of the market, which tend to be a little bit more value-oriented, there were some more sluggish earnings revisions there.
The market was starting to get baked in from potential tariff effects, or simply analysts were just reducing estimates due to the tariff uncertainty. And so I think that was really the biggest driver of the growth's relative outperformance that we've seen thus far in the last two and a half months. As we look ahead and think about value stocks, I talked earlier about the risk of slowing economic growth.
I'd say that poses a risk to that cohort for sure, but frankly, it might be adequately reflected in value stocks valuation to a degree. And I talked about the steep premium that growth stocks are trading at today. And so our thought is that moving beyond any soft hatch in growth, should we see it, that we'd expect to see broader market participation ahead, really is the earnings growth dynamic between mega cap tech stocks and the more cyclical segments of the market converge over time.
If we look into 26, we see a couple of positive catalysts for the cyclical areas of the market. I think when I talked about deregulation potentially unlocking animal spirits, and that's something that could drive some better growth for that cohort, but also the potential benefits from tax reform should that get passed through the budget this year. So we think these are factors that could help catalyze some better economic activity ahead and possibly result in some better performance in value relative to growth.
Now, if you consider how artificial intelligence, AI has certainly been a big catalyst for tech stocks over the past few years of anything, Jeff, you think can be a positive catalyst for a value stocks as we look ahead? That's a good question. So in terms of catalysts, I talked, I just talked briefly about deregulation and stimulus.
I think those certainly would be, let me, I really think that the deregulation theme is probably the biggest catalyst for value stocks. And I don't want to try to overstate its importance, but we've just, we've been through this period, several year period where the regulatory backdrop had just gotten worse and worse for the financial industry and had arguably reached extreme levels in 23 and 24 to the point where the major banks were holding more capital today than they ever have in their past, despite the fact that we were obviously, you know, 17 years removed from, from GFC. I think this is a catalyst for value stocks really because financials are such an important sector within the index.
It's the largest sector in the value index, it's about 25%. And so, yeah, I think if there's growing confidence that the regulatory pendulum begins to move back towards the middle instead of restrictive territory, you know, that could certainly help from a sentiment and unlocking a valuation upside perspective. Before I even talk about deregulation, I think the backdrop for banks and brokers are actually just really good anyway, right?
We've had, you know, pretty solid earnings revision trends over the past year or so, which I think has also helped support the group. You know, they continue to deliver, you know, solid OPEX controls. You're seeing that interest income moving higher.
And now what you're seeing is an uptick in their fee-based businesses. So things like wealth management, M&A activity, trading activity, areas where they generate higher fees and are less rate sensitive are moving up as well. So fundamentally, I think the sector is in good shape, but shifting back to the regulatory side, you know, when we look back and not just within financials, but across any sector, whenever there's broad regulatory changes, typically it's somewhat long lasting, you know, it happens over a multi-year period.
And as I mentioned, we've come out of this pretty restrictive period over the last several years. And now what we've seen is changes to the heads of various regulatory agencies. So the FDIC, the SEC, we have a new Fed chair of supervision, Michelle Bowman.
In the past few months, all of these individuals, all of these new heads of agency have indicated that the banking system really needs a more practical and transparent approach to setting regulations. And so our thought is that the regulatory pendulum could be poised to swing back towards the middle, as I mentioned, from being restrictive. And this could provide somewhat of a multi-year catalyst for the group.
Three areas that benefit from less regulation, capital, lower costs, and then time back on your hands for the senior execs. On the capital side, I mentioned this previously, but the banks are sitting on more capital today than they ever have. J.P.
Morgan talks about the fact that they've got about $30 to $40 billion in excess capital that could be deployed should there be any relaxation of cap requirements. And so in that scenario, what are we likely to see? So you can see shareholders benefit from an increase in buybacks and dividend growth.
But a company like J.P. Morgan could also reinvest, and they've done that for a long period of time. They now have more capital to really reduce costs for consumers.
I think their CEO, Jamie Dimon, has talked about the possibility of bringing mortgage costs down by 100 basis points should they be able to reinvest and drive more efficiencies in that part of their business. You could see increased lending, which has economic benefits. We probably see some improved efficiencies through investing in areas like technology.
So capital unlock is certainly a catalyst. On the cost side, it's estimated that about 5% to 10% of expenses for the banks are tied to regulatory and compliance. I'll tell you, Wells Fargo has something like 10,000 people working there just dedicated to regulatory and compliance matters.
We think that a reduction in staff certainly could lead to improved OPEX and better profitability ahead for a lot of the banks. And then on time back, similar dynamic here. A lot of the major executives have talked about spending a pretty significant amount of their time over the last several years on dealing with regulatory matters, and unfortunately less so on strategic initiatives.
We think a little bit of a shift back to more pro-growth focus and strategic initiatives also can help drive a little bit of growth in this segment of the market. As it relates to timing and when an improved regulatory backdrop starts to have a little bit of a benefit, the new heads of agencies are in place. Our thought is that you expect to hear more comments from them later this year.
We just heard something last night about a potential relaxation in SLR that was posted last night. I think the journal reported that. And our thought is that as you begin to hear more comments, it possibly lifts valuations for the group higher.
In terms of real fundamental benefits, our thought is that it probably won't happen until 2026 most likely and beyond. But as I mentioned before, we think this has legs to it over more than just one year, so we think this could be a nice catalyst over the next few years. Thank you, Jeff, for that perspective.
I understand as well you've recently attended some big investor conferences. Do you mind sharing with our advisors what you're hearing intra-quarter from management teams? Anything interesting to note?
Yes, so this is always a busy conference season in between quarterly earnings. So if I had to think through, so there's three sectors I'll touch on that I think are probably relevant as it relates to the economy in terms of sort of read-throughs. One, financials.
Two, I'll talk some industrial beings we had, and then the third, consumer. On the financial side, met with some of the biggest execs at Wells and Goldman, JP Morgan, Morgan Family, Amex, EastWest, which is a regional bank. Outlining it, trends for these companies, it's still business as usual, right?
The consumer's in good shape overall, credit's normalizing, it's healthy, lending growth is running modestly positive, so not super robust, but still a decent amount of growth. Pipelines for M&A are building. One anecdote I would share is that corporates have hit the pause button in the near term until they get a little bit more clarity on tariffs.
So I think there's interest in things like M&A, but right now things have kind of paused a little bit. So as it relates to financials, nothing really new there, it seems like business as usual. Industrials, we met with some rail operators, we met with some commercial aerospace companies and some capital goods companies.
It's interesting, many of the industrial companies have talked about seeing a tariff impact this year, though they've also discussed their detailed plans to offset this. So you'll see things like price hikes, they can move around their supply chains and produce That was kind of a big theme at a lot of these conferences. The overall impact from tariffs seems manageable.
And we would have, look, I'd say we also would have expected many to call out weakening demand due to tariffs, but that does not seem to be the case. Now the risk there is, is demand in the near term being supported by a pull forward of growth ahead of tariffs? That's a possibility.
And that's something that we're thinking about as a possible air pocket moving ahead in the near term. But I would say that as of now, it doesn't really seem to be the case. But that's something we're monitoring closely.
On the consumer, I would just say that trends for the consumer are pretty much the same as they've been, where it's been fairly uneven. So you have the high end consumer, they continue to do fine and they're spending the same. The low end consumer continues to struggle.
Now importantly, I'd point out that the higher end consumer is a little bit more important from an economic perspective, it accounts for something like 40% of discretionary spend in the U.S. So from a macro perspective, that's something we wait a little bit more. At the lower end, I'd point out that fast food trends have been sluggish and in the retail sales data yesterday, dining out declined for the first time in a couple of years.
And so you're seeing a little bit of softness in that segment. We think that's more driven by the lower end consumer. We've also seen declines in main cabin bookings on airlines.
But in our meetings with American Express, they said, you know, they're at the high end, they're not really seeing any impact. And they pointed to bookings for first class upgrades are actually up sharply. So you have this continued mixed bag on spending by income cohorts.
But the reality is the high end remains strong. And that's probably the bigger economic driver to focus on. Thank you, Jeff, for sharing those takeaways.
Jeff, it was nice catching up with you today here on UBS OnAir. Thank you for your insights and guidance when it comes to equity markets and equity positioning. My pleasure, Dan.
Thanks for having me. Thank you for tuning in. Be sure to visit UBS.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. UBS Studios is part of the UBS Chief Investment Office within UBS Global Wealth Management. Visit UBS.com slash CIO to view the latest research.
As a firm providing wealth management services to clients, UBS Financial Services, Inc. offers investment advisory services in its capacity as an SEC registered investment advisor and brokerage services in its capacity as an SEC registered broker dealer. Investment advisory services and brokerage services are separate and distinct, differ in material ways, and are governed by different laws and separate arrangements. It is important that you understand the ways in which we conduct business and that you carefully read the agreements and disclosures that we provide to you about the products or services we offer.
For more information, please review Client Relationship Summary provided at UBS.com forward slash Relationship Summary or ask your UBS Financial Advisor for a copy.