Top of the Morning: CIO Equity Pulse - Monthly performance update & outlook
Per the full note , UBS's CIO has raised its S&P 500 price target, citing the ongoing AI rollout as a key positive, while flagging risks from higher long-term interest rates, inflation, and potential over-building of data centers. The desk sees this as a constructive but cautious outlook, with the AI theme underpinning earnings growth expectations. Our own coverage shows a consensus target of 1.075, with JPMorgan aligned at the upper end and BofA contrarian at the lower end, reflecting a wide dispersion in views on the AI-driven earnings outlook. The next 30 days see no high-impact events, leaving the market to focus on earnings and Fed commentary.
What the desk is arguing
The UBS CIO's equity strategy, as presented by David Lefkowitz, is fundamentally bullish, anchored on the belief that the AI rollout will continue to drive corporate earnings and support the market. The desk argues that the recent increase in the S&P 500 price target reflects confidence in this AI-led growth narrative, despite headwinds from higher long-term interest rates.
Specifically, the desk highlights that AI remains a key positive factor for equities, with potential to boost productivity and profitability across sectors. However, it also acknowledges that rising rates pose a valuation risk, and the over-building of data centers could create pockets of excess that might weigh on sentiment. This balanced view underscores the CIO's conditional optimism.
The desk is implicitly rejecting a more bearish alternative that would see AI as overhyped and interest rates as a sufficient trigger for a significant correction. Instead, the desk maintains that the fundamental earnings backdrop, supported by AI, is strong enough to outweigh these headwinds, justifying the raised target.
01UBS CIO raised its S&P 500 price target, reflecting confidence in AI-driven earnings.
02AI rollout remains a key positive, but rising long-term rates and inflation are notable risks.
03Over-building of data centers could become a concern for the tech sector.
04UBS recommends maintaining equity exposure while monitoring risk factors.
05The market faces a quiet calendar in the next 30 days, with no major scheduled events.
Market implications
With the S&P 500 target elevated, watch for continued strength in technology and AI-related stocks, but stay alert to any spikes in long-term yields that could pressure valuations. The lack of major calendar events in the next 30 days suggests that earnings and macro data will drive short-term moves; position for volatility around Fed speeches or CPI prints if they emerge.
Risks to this view
The primary risk to the UBS view is a sharper-than-expected rise in long-term interest rates, which would compress equity multiples and offset earnings optimism. Additionally, if inflation proves stickier than anticipated, the Fed may need to tighten further, potentially derailing the AI-led growth narrative. Over-building in data centers could also lead to a supply glut, hitting tech sector margins.
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Hi everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.
We are back today with another episode of CIO Equity Pulse, a monthly touch base on equity market performance and positioning, which ties right into the release of the monthly UBS House View. Joining me here from the UBS Chief Investment Office within UBS FSI, glad to welcome back Head of Equities for the Americas, David Lefkowitz. David, great to be back with you here in August as we are making our way through the summer, though we are continuing to see a lot of activity in equity markets, which we will dive into today.
So it's great to have you back here on Top of the Morning, David. Thank you for dropping by. Yeah, as always, Dan, thanks for having me.
And yes, summer always goes by too fast, but here we are. Yep, indeed. David, as we're speaking today, I know that the monthly UBS House View publication series, the latest came out just last night.
So very timely that you're joining us today. Upfront, do you want to point out how you and the team increased your S&P 500 price target? So what can you share with our listeners, clients, in terms of the factors which led you and the team to that decision?
Yeah, sure. Thanks, Dan. So as we've been discussing over the last several months, I mean, our main message has been that we think this bull market has further to go.
And that main message is still very much intact. And in fact, we think the bull market can extend even further than our price targets had previously indicated. So we're raising them.
We're raising our price targets, not substantially, by about 2.5%. Our year-end S&P target goes to $8,100. And then for the middle of next year, we're at $8,400.
And so that's about it. If you think about to June of next year, it's about 12 months from now, and a little bit less than that. We're looking for about a 10% return.
So it's a pretty normal type of return for equity markets. And the main driver of this increase is really just the surging in corporate profits that we are currently seeing. And I would say earnings are really firing on all cylinders.
You've got clearly the AI infrastructure build-out. That is really supercharging the numbers. And I'll get into that in a little bit more detail in a second.
But consumer spending also has been pretty resilient. Obviously, there's pockets of strength and weakness. But overall, it is pretty good.
And then the third element here has been the cyclical side of the economy. Think manufacturing, industrials, transportation, banks, things like that. That has all improved as well.
So really, earning strength has really been quite robust. And just to highlight that point, in the second quarter, we're looking about what we think earnings will come in. We're not quite done yet, but almost there. 33% or so earnings growth in the second quarter.
That's about 5% better than we had expected. On top of that, the guidance has also been solid. So the earning strength has been pretty evident in the first half.
We sort of waited to raise our numbers a little bit to just get more validation. And now we have that validation. So we're bumping up our earnings numbers for this year.
We're now looking for 25% earnings growth. That's an increase of about 5 percentage points. And next year also, we upgraded those numbers looking for 14% growth.
So we think the growth, it'll slow, but it'll still be quite good. And then the main drivers of the increase really are a lot of it is that AI infrastructure build out. It's mostly related to semiconductors and those segments of the market.
Also, some of the energy companies as well. But the increases are, but we're seeing healthy numbers really across the board. It's just those two areas I highlighted, that's where we're seeing the largest increases in our expectations.
But generally, we're upgrading our expectations pretty much across the board, but just by a smaller magnitude. And so just to put a punchline on this, we're looking for $400 of earnings for next year. And we put 20 times multiple on that or so.
And that's how we get to our 8,100 year end price target. That's the new price target. David, if we touch on these pillars a bit further, that support, this upside you're anticipating for equity markets, let's talk a bit about initially the AI rollout.
You believe it remains a key positive for the market. Can you expand on that for us? Yeah, exactly.
So the AI infrastructure, that is clearly supercharging the numbers and the earnings for the companies that are beneficiaries of that, the picks and shovels folks who are building all of this infrastructure. So that was certainly a big part of the upgrade. I mean, look, I think the key question is, will the capital spending continue to be there?
And we think the answer is it will. So this year, a really large increase in capital spending. I mean, we're looking for $900 billion of AI infrastructure spending.
That's up, that's nearly double what the number was in 25. But we think we're going to still see pretty robust growth in 2027. We're certainly looking for a bit of a slowdown in the growth rate itself, but still a very healthy 35% growth.
So $1.2 trillion or so. And as we've learned over the last few years, we keep on having to revise higher our estimates. So we'll continue to look at that.
I also think it's important to note that the signs of monetization have gotten better. So cloud revenue growth just hit its highest level in seven years. The backlog for these hyperscalers is now over, it's around $2.3 trillion.
So a huge amount of backlog. And some of the AI native companies, the ones that are really driving this, the ones that are creating the models and that everybody's using, for some of those private companies, we've seen just a very substantial acceleration in revenue growth. And so I think those are all good signs that we are seeing the monetization come through.
And so therefore, we think there's good support to the capital spending, which, yeah, that's a really crucial variable for the earnings growth, not only for the market, but for some of the most important and largest segments of the market. So bottom line, we still think this is a key earnings driver that remains in place, although it likely will moderate a bit as we go into 2027. David, in prior episodes, we've spent some time talking about Fed policy, which is part of your framework, a very important factor here.
What is CIO's current outlook for the Fed? And how does that impact the equity market? Right.
So, you know, just as a reminder, we have no, we're not forecasting any rate hikes this year. And we actually have two cuts penciled in for next year. And so, you know, a month ago, that looked like a pretty out of consensus view when the market was expecting the Fed to start hiking.
But we got cooler inflation, we got a little bit of softness in the labor market report, the retail sales report was also a little bit softer. So now the market's coming around to our view that the Fed is not going to hike. And I think we're going to see data in the coming months that's going to continue to validate that view.
You know, especially if you look at inflation, you know, inflation right now is higher than target for, in our view, reasons that are for a couple of big reasons that are largely temporary. One is that the tariffs are still contributing to higher than normal inflation that's beginning to improve. And we think that'll continue to be a source of disinflation.
And then secondarily, the energy situation, you know, oil prices have moved up. As long as they don't move higher, which is consistent with our view, we don't think they're going to move higher from here, then the inflation that's coming from the energy complex will eventually, over the next, you know, nine to 12 months begins to subside. So that'll start moving inflation readings closer to the Fed's target.
And we think that that's why they will not feel the need to raise interest rates. And yes, I mean, the Fed is super, I would say, you know, one of the most important variables when it comes to the outlook for equities. You know, if they're tightening policy, you know, just go back to 2022, when they were raising interest rates pretty aggressively.
Yeah, I do think that that had a negative impact on corporate profit growth in some areas. So if they're tightening policy, that's something to watch. But as I just indicated, we don't think that that is the most likely outcome at this point.
David, running with rates a bit further, have to single out how long term interest rates. They've been on the rise. They've been moving up.
How do rising rates impact equities? I think this is a really important point. I mean, I think we're in a regime where higher rates are a headwind, lower rates are a tailwind.
And that's actually a pretty substantial shift from the, you know, I call it a regime. That's the opposite of what we saw from sort of the dot-com period, you know, think around from, say, like 2000 until really until 2021, you know, through COVID. For that 20 years, it was the opposite.
And the reason things have flipped is that the main concern, I would say from, say, the year 2000 to 2021, the main concern that – and don't forget, we had the dot-com bubble burst. We had the financial crisis during that period. We had slowdown in China.
The biggest concern in those 20 years was too much deflation risk. And now we're shifting to the concern is that there's too much inflation risk. So as a result – so, you know, when the big concern was deflation, when rates went down, the market got worried.
The equity market got worried because you don't want to slip into deflation. You don't want price increases too low because that makes the real cost of debt significantly higher. At the same time, you don't want too much inflation because that can wreak havoc on corporate profits, at least in the short term, and consumer purchasing power and things like that, and erode purchasing power.
So you want a happy medium. But we're really now in the regime, I would say, where inflation has become the bigger risk in the equity market's estimation. And therefore, in general, rate increases at the long end are going to be a bit of a headwind for equities.
Now, that doesn't mean it's one-for-one, because rates are up this year and equities are up this year as well. And we also think that rates will come down this year, partly because of our view on what we think inflation – how inflation is going to behave. And the other thing I would also keep in mind – and we're getting a lot of questions on this move back up in interest rates – but if you look at the tenure, we've been in largely a range over the last three years, and we still haven't broken the high that we hit in 2023 when the tenure hit 5 percent.
So we're still below that. So rates have been in this new range. We think we're going to stay within the range and actually go back down to the lower part of that range as the inflation data improves, as we were just talking about, Dan.
But look, if we're wrong and inflation becomes more sticky and rates move higher, then I think that would be a headwind for stocks. I mean, not something that would necessarily totally derail the bull market, but I think that would lead to at least some valuation compression going forward. Sticking with the topic of headwinds, risks, as we've talked about in previous episodes, chief among them as conveyed at the time, you've pointed out inflation, overbuilding of data centers as key risks to equity market progression.
Are those risk factors – inflation, overbuilding of data centers – are those still on your radar? Yeah. I mean, as we just discussed, I think those still, in my mind, are the biggest risks.
I mean, we talked about inflation and the Fed a bit. And, you know, I mean, if you look back at – I mean, there's the old mantra, right? Don't fight the Fed.
So I think – and I think there's a lot of solid evidence to suggest that, yeah, when the Fed is raising interest rates – but importantly, raising interest rates to a level that they want to slow down the economy, right? It's one thing if you're raising interest rates from a really low level to something more normal. But if you're raising interest rates from, say, normal to something more restrictive, that's when you need to be more cautious.
And, yeah, look, Fed funds rates are not – they're not low. I wouldn't say they're super low. So if we got – you know, rate increases more than – you know, it would have to be more than a handful.
You know, it would have to be like three, four, five, six, you know, in that range. That would definitely continue to be – that would be, I think, a risk to equity markets. I think the thing I would focus on is would the yield curve invert?
You know, that could be a risk. And then – but, again, we don't think that's not the base case. The second is, yeah, overbuilding data centers.
I mean, look, as we've just been talking about, that's been a huge driver for earnings. And if for some reason, you know, we see a very substantial slowdown, the slowdown would have to be more than what the market's currently expecting, then that would be, I think, a big headwind for – more than a headwind. I think you'd see a lot of the AI-levered companies, AI infrastructure-levered companies, you know, really having some substantial downside risk.
So that's not anything we're expecting in the near term, but something we watch closely, and that's why we spend a lot of time monitoring monetization and things like that, and any new technologies that could come out that make the use of these data centers more efficient. The last thing I would say, and we're going to have a lot more to say about this, we've got an election coming up, midterm election. Markets are going to probably start to focus a little bit more on that as we get past Labor Day.
Look, I don't think this is going to be a huge market-moving event. I mean, it's a midterm election. It's not a presidential election.
So regardless of the outcome, we're not expecting many policy changes or hardly any policy changes because the White House, the President's not changing. And so, you know, it could always cause some short-term volatility, but I don't think that would really have a significant impact on the overall performance of equities. A range of risk considerations to be mindful of.
A quick plug, ubs.com slash election watch for investment insights on the U.S. midterm elections, which, David, I'm sure we'll talk more about in the weeks and months ahead leading up to November. But mindful, David, as we begin to wrap up of the risk considerations you've shared with us, coupled with your performance outlook as well for U.S. equities, what are your positioning recommendations across equities at the moment? Yeah.
So, Dan, our main message here is stay invested, but also be mindful of any concentration risk that you have. That's been a consistent message of ours over this whole year, you know, especially because some of the companies have, you know, within tech and AI areas and AI related areas have experienced some really dramatic gains. You know, we just think it makes sense to make sure you don't have too much exposure in those areas.
But, you know, we're still bullish in general. I think you want to continue to have exposure to structural growth themes. Those are our trios, our transformational innovation opportunities.
We separate them into AI, power and resources, and longevity. And just, you know, we just saw yesterday how, you know, healthcare innovation continues apace with some really exciting news about a vaccine that could help with cancer outcomes. So, yeah, I just think it's important to have those innovation drivers in your portfolio and our trio strategies, we think, are a great way to capture that.
And then from a sector perspective, you know, I also think it's important to, you know, at the same time, we like the structural growth stories, innovation drivers, at the same time, have some cyclical exposure. We talked about how, you know, the cyclical side of the economy is doing well. So we like financials, we like industrials in that segment of the market.
And, you know, I wouldn't ignore ex-US either. You know, this is really a global story in a large sense, a global industrial recovery, and a lot of opportunities out there and, you know, don't need to focus solely on the US. Well, David, always a very helpful touch base.
Thank you for spending some time with our listeners, our clients here on Top of the Morning for the latest episode of the Equity Pulse from CIO. And as always, David, do look forward to our next conversation here on Top of the Morning. Yeah, I appreciate that.
I look forward to it as well. Thank you, David. And again, for you, our listeners, we have been joined today by David Lefkowitz, head of equities for the Americas from the UBS Chief Investment Office.
Again, this has been the CIO Equity Pulse, which is a monthly touch base on equity market performance and positioning, ties into the monthly release of the UBS House View, which is available up on the website, ubs.com slash house view, all one word. For clients of UBS, please be sure to reach out to your UBS financial advisor to receive a copy of the House View monthly letter and investment strategy guide from the Chief Investment Office. From UBS Studios, I'm Dan Cassidy.
Thank you for joining us. Visit ubs.com slash CIO to view the latest research. This material has no regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and is published for informational purposes only.
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