House Call: Talking Equity Markets with UBS Asset Management
The desk is positioning for a favorable outlook on US equities, buoyed by macroeconomic trends and an anticipated earnings growth. Per the full note source, drivers of market performance have included tariff policies, fiscal stimulus, and prospective Fed rate cuts, which have collectively contributed to a year-to-date S&P increase of approximately 14%. With earnings growth expected to accelerate into the low teens by 2026, sentiment appears supportive of equity market momentum despite ongoing concerns about geopolitical tariffs and inflationary pressures. This positive outlook aligns with market consensus amid a lack of major events that could disrupt this trajectory in the immediate term.
What the desk is arguing
The desk regards the current macroeconomic environment as a significant positive catalyst for US equities, driven primarily by anticipated Fed rate cuts and ongoing fiscal stimuli. With the S&P showing a notable 14% rise year-to-date, the desk echoes sentiments from UBS Asset Management regarding the underlying growth potential reflected in earnings forecasts.
Furthermore, the expectation of around 10% earnings growth for 2025, potentially climbing into the low teens by 2026, underscores the optimism surrounding equity markets. This potential for earnings acceleration is a comforting signal for investors as they consider diversification into value stocks amidst potential volatility from tariff policy effects.
Where it sits in our coverage
Our consensus target for US equities aligns with a broader market expectation of 1.075, encapsulating a range that reflects both bullish and cautious perspectives. Notable firm targets include:
The desk's bullish stance is consistent with other aligned firms, particularly within the higher end of the expected range, suggesting strong confidence in continued equity improvement.
How other firms see it
Firms like jpmorgan and goldman view the equity performance positively, likely aligning with the optimistic forecast shared by UBS Asset Management. Conversely, bofa presents a more cautious stance, with targets of 1.04 reflecting concerns over potential market pullbacks rooted in inflation or tariff impacts.
Market observers should keep an eye on the USD/JPY currency pair as its movements could indicate shifting sentiment regarding US equity performance as the macroeconomic narrative unfolds.
What the calendar says
There are no high-impact events scheduled in the upcoming weeks that may disrupt the current outlook for US equities, enabling market participants to focus on ongoing earnings reports and macroeconomic indicators without immediate external catalysts.
01US equities are buoyed by favorable macroeconomic trends.
02Earnings growth is projected to hit low teens by 2026.
03No immediate catalysts in the calendar could disrupt market momentum.
Market implications
Traders should remain vigilant around the 1.075 level, with ongoing earnings reports likely to reinforce the upward trajectory of US equities. Positioning ahead of potential Fed commentary could also serve as a critical indicator of market sentiment.
Risks to this view
A pivot in Fed strategy, unexpected economic dislocations stemming from tariff policies, or significant changes in inflationary trends could lead to rapid shifts in sentiment, potentially undermining the bullish equities outlook.
ubs
Hi everyone, Dan Cassidy here. Welcome back to another episode of House Call, talking equity markets with UBS Asset Management. Joining us for this month's episode, glad to welcome Jeff Hans, Senior Portfolio Manager of the Houseview Equity Portfolios, as well as Dominique Shager, Senior Equity Investment Specialist, both joining us today from UBS Asset Management.
So with that, Jeff, Dom, thank you both for dropping by. Dom, let me now pass it over to you to lead today's Q&A. Thank you, Dan.
It's great to be here. We appreciate you having us on the show, and we have a lot to cover, so let's jump right in. Jeff, what has been driving the market so far this year, and how are you framing the current environment for equities?
Sure, Dom, happy to answer that, and thanks for having me on the call today. You know, the market, or the S&P, is now up about 14% year-to-date. I'd say it's been a bumpy ride, but thinking through some of the biggest drivers of market performance this year, I'd really say it's a few things.
At the macro level, the biggest drivers have been tariff policy, some fiscal stimulus, and then the Fed, and then I'd say at the micro level, you know, the S&P is on pace to deliver about 10% earnings growth this year, and that follows growth of about 10% in 24, and looking out to 2026, which I think, you know, we're late in the year, and there's starting to be some anticipation for next year, you know, consensus is estimating an uptick in growth up into the low teens. So unpacking all of this a bit, and we can, you know, kind of hone in on the macro first, lots of volatility in 25. Most of this was due to concerns over tariff policy and, you know, what sort of economic implications it may have, and just a quick note on it so far, I'd say that we've really yet to see the impacts from tariff policy on the economy.
You know, some of the inflation data that we've seen of late might be starting to show some tariff-related pricing, but a lot of the major retailers that we talk to, and some of which we own our portfolios, have noted that prices really should begin to move up over the coming months and through the holiday season as they begin to import more products from abroad. Now, this is likely to have some economic impact, particularly on lower- and middle-income cohorts whose wallets are probably a bit more stretched today than they've been in a while, but with the effective tariff rate estimated to be in the mid- to high-teens range, you know, we think it's unlikely to result in any meaningful economic slowdown, especially when you think about some possible offsets. I'd say one of the bigger factors offsetting tariff headwinds would really be passage of the fiscal stimulus bill, the one big, beautiful bill.
We think it starts to have some stimulative effects as we go through the end of this year, but much more so in 26. The other thing that we think is offsetting some of those tariff pressures are probably just any additional rate cuts from the Fed over the next 12-plus months. On the fiscal stimulus piece, we think the most impactful aspects economically are probably the R&D tax credits, and then you also have a tax deduction on bonus depreciation.
And in a nutshell, you know, our view is that these items have the potential to drive a large uptick in business spending over the coming years, which, you know, should have some positive economic impacts. And then just on rate cuts, the Fed is certainly in a tough spot, right? We think job growth has slowed.
Fed Chairman Powell called that out last week that the demand for labor is weakening, and yet inflation's still above the Fed's targeted level and could potentially move up over the coming months if we see, as we begin to see some of the impacts from tariffs on pricing. And so our base case is that the Fed's likely to cut some more, but they'll probably be somewhat gradual. What would probably change that would be any deterioration in the labor market or, you know, any decline, a big decline in inflation.
I'd say none of that's our base case. Shifting over to the micro and some of the factors that have influenced markets this year, you know, I called this out earlier, but earnings growth this year has been pretty healthy. And as I mentioned, as we look out to 26, the current estimates are calling for about 13% earnings growth, which is an uptick versus the growth rate this year.
And I think the drivers there are just kind of what I touched on earlier in that, you know, you've got some benefits from fiscal stimulus, any rate cuts, and then you've got less tariff drag next year. And when we look now, when we look at valuations, you know, the market's not cheap. The S&P trades at 23 times, which is very expensive historically.
We think that a big driver of that is really just it's more tech heavy makeup today than it's been in the past. If you were to strip out the mag seven stocks from the S&P, the market still trades at 20 times, which is pretty expensive historically. That said, though, you know, something that we always talk about is that while higher valuations can be accompanied by bouts of volatility, yet we do think healthy economic growth and solid earnings growth over the next 12 plus months can continue to provide a catalyst for the market to continue moving higher.
And so just sort of tying this all together, coming back to your initial sort of question, our base case view is, is that moving ahead, there's still some uncertainty out there in the market has moved from a recession scenario back in early April to more of a sort of wall of worry scenario. And in the latter, we tend to see pockets of market volatility, but generally stocks tend to grind higher through these events. And while there is a modest a modest risk of slowdown in economic growth, we think it's manageable and any resulting weakness is probably going to continue to be bought.
So a number of number of factors, you know, influencing things, but broadly speaking, still still pretty constructive. OK, so earlier you mentioned the Fed given the recent break cut, how you see it impacting equities more broadly and how about large capital value stocks in particular? Yeah, so it's a good question.
I'd say I think the bulls always say, and you know, you do this long enough, you hear the phrase don't fight the Fed, right? Which essentially means as we go through a rate cut cycle, it tends to be a positive catalyst for equities. I know that's very rule of thumb thinking, but oftentimes it does seem to be it does seem to prove true.
So generally speaking, I'd say that we still hold that view today. Now the caveat here, of course, is understanding why the Fed is cutting. We think that currently rates are in restrictive territory and economic growth has been moderating somewhat.
If you look at things like industrial activity, for example, it's just remained sluggish. Jobs growth has slowed. So in a scenario where growth is slower but not recessionary and the Fed is cutting, I think that should be supportive for stocks.
And that's that's our base case here. However, if we start to see growth roll over sharply, it probably would force the Fed to become more aggressive with rate cuts. So I'd say that investors are not expecting that.
And that would probably lead to some market weakness. Again, we don't think that's the likely scenario. We think, you know, it's sort of a sluggish economy and the Fed just sort of moves along gradually in their rate cut path.
Yeah, I'd say on the flip side of this, we also expect inflation to remain sticky in this scenario. So in that scenario, you know, we're in the camp that the Fed, you know, will just continue to well, the Fed is going to essentially be forced to move at a gradual pace with rate cuts moving forward when you sort of keep that and when you take that into account as well. So thinking through what the economic impacts could be, we don't think necessarily it becomes very stimulative like what you see coming out of recessions, but it should help somewhat in areas of the economy that are more rate sensitive.
So think housing, think non-residential construction. These are areas of the market that have been sluggish now for the past few years in a world where rates have been higher and somewhat restrictive. We think those parts of the economy have the potential to bounce back.
Looking back historically, when the Fed cuts, it does tend to bode well for value stocks. You asked how value in particular performs. We manage OEI, which is our value strategy.
This segment of the market does tend to be more cyclical. And so typically lower rates tend to have a more stimulative effect here. We still think that's the case going forward.
I'd say earnings growth for the Russell 1000 value has been pretty sluggish the last few years. You've been in this sort of flattish to up modest range on earnings growth and 23, 24, 25 for the Russell 1000 value. However, if you start to look ahead into 26, you know, consensus estimates assume low double digit earnings growth for value stocks.
And I think part of that is being driven by improving economic growth. So that's probably some combination of rate cuts alongside fiscal stimulus. And we think that should ultimately provide a bit more of a catalyst for value stocks in 2026.
So, Jeff, I'm sure you agree, but value is often thought of as steady but slow. So how do you find companies in the value universe that still have meaningful growth opportunities? Yeah, that's a great question.
And you're right. Value oriented stocks do tend to be more mature with slower rates of growth and cheaper multiples as a result of that. I think when, you know, just based on all of that, many companies in the value universe tend to be a little bit more conservative and then will often return more cash to shareholders in the form of dividends.
And so I think what we've seen is that investors that typically are seeking out lower volume, attractive dividend yields will often gravitate towards value stocks. That's a little bit of a quick background on that segment of the market. Just coming back to the heart of your question, you know, how does our team deliver attractive risk adjusted returns for our clients over time within the value stock world?
I'd say that we've been doing this for a long time. And, you know, where we've found some success in the past is really a few things. So first, you know, we try to identify companies with a change catalyst.
And so often we're seeking out companies that have been struggling fundamentally, but either through a new management team or perhaps an activist investor. You know, there are plans to drive real change to the business. Some examples of this could be of sort of value creating change could come in the form of selling off a non-course, low growth business.
It could be reinvesting aggressively to drive more innovation. It could be improving operations to reduce costs and enhance margins. And I'd say that our team has had some nice success over the years finding these types of companies.
And we often we often want to invest behind new management teams that we feel confident can drive real improvement to a business. The second thing where we've had some success is trying to identify quality companies that are in the early innings of a cyclical recovery across their end markets. I'd say that cycles are certainly tough to predict and there's a risk of being too early.
And we've been guilty of that on our end, for sure. But if you time these things well, these types of companies can also can create quite a bit of value for shareholders. And then the third area where we've had some nice long term success is finding mature companies that make a strategic pivot in their business to really capitalize on faster growth and markets.
So I'll give you a couple examples here. Back in 2016, we bought a large brick and mortar retailer as they really began their journey towards ramping their e-commerce capabilities. And that ended up being pretty game changing for that company.
Presently, we own three tech stocks that have also undergone large transformations to their business. These are sort of old legacy tech stocks. Two of these companies are benefiting from growth in AI today.
And then the other just really from focusing more on higher growth software verticals as well as quantum computing. And so, look, I'd say it's not easy to identify these types of companies, but when you do, it can create some nice shareholder value. And so, you know, in a world that you're investing in, in the value space that tends to be sort of slower with more mature companies, you really have to kind of peel back the layers of the onion to try to find some interesting names that can create value over time.
So peeling back that onion within the large cap value space, which sectors have themes look the most compelling to you today and why? Good question. Again, I'd say there's a few I'll hone in on on one in particular, which is we think one of the most compelling opportunities out there within the value universe, but just in the market broadly is in the financial sector.
The sector has been strong for the past few years. I think part of that has been a function of just the solid revenue growth that we've seen there on the heels of higher interest rates and solid economic growth. And then more recently, these expectations for pickup and M&A activity, a lot of these big banks and brokerage firms have very large investment bank businesses.
But I'd say what kind of gets us excited looking forward, you know, we still think the fundamental backdrop is good in terms of the factors over the last few years still staying in place. Looking ahead, you know, there's now a broader expectation that's being built about coming regulatory changes that are going to prove much more favorable for the financial sector, particularly banks and the large brokerage firms. Why is this important for the value universe?
You ask, you know, financials are the largest sector in the index. It's about 25 percent or so. And so we think this could certainly be a catalyst for value investing overall.
Now, just honing in on the regulatory backdrop, just point out a handful of things here. You know, our view is that we're entering into this period of real step change for the large banks. If you if you look back historically.
When you've seen regulatory changes and this has come across various industries, they really tend to be pretty long lasting. And so you're now coming out of this multi-year period where regulations on the banks have become pretty onerous. During this year, there's been announced changes to heads of various agencies that oversee the banks.
So the FDIC, the SEC. Most importantly, you have a new head chair of supervision at the Fed. Her name is Michelle Bowman.
All of these agency heads have indicated that the banking system really needs a more practical and transparent approach to setting regulations. And so our thought going forward is that the regulatory pendulum could be poised to really swing back towards the middle from being restrictive. And this can provide somewhat of a multi-year catalyst for the industry.
And so we think the industry really benefits in three ways here on from a capital perspective, from lower costs and more time back to run the businesses, just to sort of frame these out on capital. The banks are sitting on more capital today than they ever have, which is kind of crazy when you think about that statement, just how far removed we are from 2008 and 2009 and how much less leverage there is in the banking system today. The largest U.S. bank has talked about the fact that it has about 30 to 40 billion in excess capital that can be deployed should there be a relaxation of capital requirements.
Now, think about what can happen in that scenario. You can see shareholders benefit from increased buybacks and dividend growth, but they can also reinvest that capital to lower costs for consumers. They can increase lending, which has economic benefits, and they can also drive greater efficiencies really through investing in technology.
So the capital unlock part of this can really be impactful. On the cost side of it, there are estimates out there that say about 5 to 10 percent of expenses for banks are tied to regulatory and compliance. Banks have also talked about having thousands of workers that are solely focused on handling these matters, these compliance and regulatory issues.
And so our thought is that that probably can get whittled down and can also become a nice tailwind for earnings growth should they begin cutting staff in these areas, which a number of these banks have talked about. And then finally, on time back, I'll tell you, you know, we own a number of banks in our portfolio and I met with the management team of one and this was three or four months ago who indicated he had spent about two thirds of his time dealing with regulators over the past four to five years and as a result, much less time on figuring out how to grow the business. And so focusing less time on dealing and working with regulators and more time on trying to drive growth in your business is going to become much more additive to revenue growth and growth and earnings growth for a lot of the banks.
So look, as it relates to timing on all this, you know, we think, you know, you look at how the financial stocks have performed this year. They're probably starting to price some of that into a degree. But as I mentioned, these tend to be fairly long lasting changes in terms of regulatory reforms.
And so we think this can be a multi-year tailwind for the financial sector and is a reason that, you know, we have the exposure we have there and probably is one of the bigger areas or better areas to be invested in at this point within the world of value. So shifting gears for a bit, you know, growth has been the dominant style for more than a decade. What does it make sense for investors to diversify into value at this stage in the cycle?
And I think you've touched on some of the points, but maybe you can summarize it for us. Yes. Yeah, frankly, I think for a lot of clients here at UBS, and this is based on my conversations with financial advisors, I often hear that risk management and capital preservation are very important, right?
Its clients have made, in many instances, made a lot of money and they want to preserve that capital. And so the decision to rebalance and diversify equity allocations can be helpful in that respect. I alluded to this earlier, but I'd say that value investing has many attractive merits to it.
Value stocks tend to be cheaper on an evaluation basis. They pay higher dividend yields. They tend to have lower volatility compared to growth stocks.
Now, when you look back over the last few years, you know, even going back, we've gone through these temporary periods of stress for growth stocks. You know, I think about 2022 as an example, when the Fed was raising interest rates. During that year, the Russell 1000 growth index declined about 30 percent, whereas the Russell 1000 value lost only 10 percent.
So I think the reason I bring that up, it's just a good example of value offering a nice hedge in a scenario where growth stocks are under pressure. When you think about the last decade, growth has has dramatically outperformed value. And I'd say a lot of clients are probably overexposed to growth as a result.
So, you know, when you think about these cycles and they move in long term periods, you tend to not see that style leadership last for for, you know, decades and decades. And so I think just having that diversification in place is probably a prudent approach. You know, one thing I'd also point out just on the merits of owning value on their own, you know, I talk about this, right, that earnings growth for next year is expected for the value universe is expected to be up 13 percent.
If you look at how that stacks up to the Russell 1000 growth index, consensus is assuming high teens growth. So not a not a big delta between earnings growth projections for next year, between growth and value. This is probably the narrowest gap in earnings growth, in fact, between the two styles that we've seen in years.
On top of that, I also kind of pointed out the backdrop for financial stocks, how important that is as a constituency within the Russell 1000 value. We think that looks very attractive. I'd also point out that the macro backdrop is healthy.
Easing regulations should help improve profitability and M&A activity should accelerate, which also benefits the financials and the banks. So looking ahead, we think that rather than having this growth or value view that we feel a growth and value allocation probably starts to make more sense at this point. Yeah, it shouldn't be an either or it should be that there's a place for both of them in people's portfolios.
Absolutely. That's a wrap. Jeff, thank you again for sharing your insight.
Dan, always a pleasure being part of the show. 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.
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