How should I be positioned? with Steve Chiavarone (Federated Hermes) and Jason Draho (UBS CIO)

Jason Draho · UBS Global Wealth Management

Forward S&P P/E fell from over 22 to about 19 on strong earnings; constructive on equities for multi-year.

Jason says the forward S&P 500 multiple fell from over 22 early in the year to about 19 because earnings growth has been so strong. This makes equities more attractive compared with bonds, since yields are higher. He acknowledges the counter-argument that the market should be valued on trend, not current, earnings. He still says he is constructive on equities over a multi-year view, with the earnings-driven de-rating giving him comfort.

“one of the things that gives me comfort about the equity outlook is that the forward multiple on the S and P 500 has declined this year from over 22 early in the year down to about 19 now because earnings growth has just been so strong.”at 17:53

Steve Chiavarone · Federated Hermes

S&P 500 fair value cut to 20x because higher margins and an asset-light mix justify it; no compression expected.

Steve rejects the idea of a static long-run average P/E. The index has shifted from about 50% manufacturing in 1990 to about 18% now, with innovation sectors rising to about 52%. Profit margins have risen from just over 6% in 2009 to above 15%. He argues investors would not pay the same multiple for a more asset-light, shareholder-friendly index with higher margins, so he cut fair value from 22x to 20x. He also argues that P/E tends to peak with euphoria before recessions, not compress steadily beforehand, so an orderly decline in multiples is unlikely. Named low-multiple AI bottleneck chip and industrial names also weigh on the index multiple.

“why would you pay the same price for a more asset light index with more shareholder friendly return of capital and higher profit margins? You wouldn't.”at 20:20

Steve Chiavarone · Federated Hermes

S&P 500 can reach 10,000 by end of next year on consensus earnings growth, with no multiple expansion.

Steve's firm set a bullish two-year S&P 500 view early in the year. He argues the index can reach 10,000 by the end of next year if earnings grow about 15%, in line with consensus, and the P/E stays at a fair value of 20 times. He says he does not need the market to get more expensive, and sees risk to the upside rather than the downside.

“I don't need the market to get more expensive. I just need earnings to come through... at consensus earnings growth and no multiple expansion, we can get the S and P to 10,000 by the end of next year.”at 22:54

Steve Chiavarone · Federated Hermes

Overweight equities; prefer them over longer-duration bonds while inflation risk exceeds growth risk.

Steve's firm is overweight equities and plans to add to them on rebalancing, while staying underweight longer-duration fixed income. The reason is that inflation risk currently exceeds growth-slowdown risk, and equities handle inflation better than long-duration bonds. He argues equities sit at the top of the stack. He would buy weakness in equities, since the worries on the list are resolvable one at a time.

“we're overweight equities and when you think about rebalancing, we're gonna wanna add equities and remain underweight longer duration fixed income until the risks to growth are greater than the risks to inflation.”at 31:04

Steve Chiavarone · Federated Hermes

Overweight US large and small caps and cyclicals, with small caps set to lead as the tightening cycle ends.

Steve's firm is overweight the US, both large and small caps, and prefers growth companies and cyclicals over a value-versus-growth framing, which he says is now hard to define. He expects small caps to keep leading as they move past the end of the tightening cycle, supported by a healthy economy. The mega-cap tech trade is less favoured, with a possible capex slowdown being good for hyperscalers, while the AI infrastructure play still spreads into industrials, utilities and materials.

“we're overweight The US and we're overweight both large and small, particularly as we get closer to the end of what could be a tightening cycle.”at 32:47

Steve Chiavarone · Federated Hermes

US economy bullish medium term, driven by the largest infrastructure build since the railroads.

Steve's bullish medium-term outlook through next year and into 2028 rests on an infrastructure build spanning AI, grid modernization, reshoring and new domestic manufacturing. He calls it the biggest infrastructure build since the railroads, and the biggest globally since China industrialised 25 to 30 years ago. He says it is driving employment, with hiring much stronger this year, and supports consumer spending, as shown by the latest retail sales data. He also cites strong corporate investment.

“it's grid modernization, there's reshoring, there's new domestic manufacturing that's also occurring, is the biggest infrastructure build since the railroads.”at 3:46

Jason Draho · UBS Global Wealth Management

Constructive on US economy through end of 2027; growth resilient with Q3 GDP tracking around 3%.

Jason is constructive on the US economy over the next twelve months and through the end of 2027. Growth has been resilient despite many flagged risks, and the latest data look even stronger: retail sales were strong in August, Q3 GDP was tracking about 3%, and the labour market has re-accelerated. Capex is at a level not seen since the 1990s, and he sees a 'roaring 20s' type of scenario with a couple more years of very strong growth. He thinks the 1990s, not the 1970s, is the better parallel for stagflation worries, and that this has been accurate so far.

“Constructive certainly on The US economy, let's call it the next twelve months, but even like through the end of twenty twenty seven,”at 5:35

Steve Chiavarone · Federated Hermes

S&P 500 earnings growing about 15% a year for two years, with margins growing at unprecedented rates.

Steve sees earnings growing at a rate he calls unprecedented outside a recession, with 15% growth expected in each of the next two years. He says margins, even after stripping one-offs, are growing about 9%, a pace only seen between 1995 and 1999. He links this to a consumer that is strong, corporate investment at a high level, and the AI infrastructure build.

“We're seeing earnings grow at a rate that's really unprecedented unless you're coming out of a recession. And so we see 15% earnings growth in each of the next two years”at 4:22

Jason Draho · UBS Global Wealth Management

S&P 500 earnings growth of about 14% next year, after around 30% this year.

Jason's team forecasts about 14% S&P 500 earnings growth next year, with no 2028 forecast yet. He says this is in the ballpark of Steve's 15% and that 2026 earnings could end up around 30%. He concludes that the earnings chart is comfortable.

“We don't have a '28 forecast, but for next year at 14%. So all within the ballpark after this year, it could be around 30% when it's all said and done.”at 17:37

Jason Draho · UBS Global Wealth Management

Expects one more Fed hike in December; beyond that the path is uncertain with no forward guidance.

Jason says last week's hike was an easy call, since the market was pricing a 95% chance and the economic data is strong with inflation too high. He expects one more hike in December, also an easy call. Beyond that, he finds the Fed less predictable because Warsh gave no forward guidance. He asks whether the reference to removing accommodation is risk management or a sign that policy is genuinely loose. He pushes back on Warsh's performance in part for this reason.

“Sure, hike. Not a big deal. And even I think our views will do one more in December. Think that's another kind of easy call.”at 11:20

Steve Chiavarone · Federated Hermes

Warsh's 'dose of accommodation' remark signals only one to two more hikes, not severe tightening.

Steve reads Warsh's line about removing a dose of accommodation to reach the target faster as a non-restrictive signal. He says the Fed is not trying to slow the economy, and that the neutral rate is higher. Against three cuts last year, he expects one or two more hikes, not anything more severe. The unanimous committee and the dot plot, which he reads as bounding the hikes, reinforce this view. He says equity markets are not derailed by it, and that a shift to 'inflation is running away' language would change his mind.

“removing a dose of accommodation to get to our target faster... That would imply one or two more hikes, but not necessarily anything more severe than that.”at 15:33

Steve Chiavarone · Federated Hermes

Long-term Treasury yields trend higher; a move from 5% to 6% would not be a regime change.

Steve says 2008 to 2020 was low growth, low inflation and low rates, and that world is gone. With growth near 5.5% to 6% nominal, potential growth is rising, which requires higher market rates. He says capex is tomorrow's productivity, which drives trend growth. Inflation expectations are not materially higher and the deficit is smaller than at the COVID peak, so he doesn't blame it for higher rates. Competition for capital from hyperscaler debt issuance is a factor too. He points out that the 10-year yield has risen from about 1.5% to 5% while equities hit record highs, so moving from 5% to 5.5% or 6% isn't magical.

“On a 6% growth environment or a 5.5% to 6% growth environment, that does necessitate higher rates because it means that the potential growth of the economy is rising.”at 12:48

Steve Chiavarone · Federated Hermes

Overweight the 0-2 year curve; market prices three to four hikes, but he expects two or three.

Steve's firm likes cash, ultra-short bonds and the two-year part of the curve. The market is pricing three to four hikes, while he expects two or three. This gives an attractive starting yield around 4.75% on a fairly flat curve, with room for price gains as the hike path is repriced. He also cites a strong two-year economic view as supportive of credit at the short end.

“Within fixed income, we do like the short end of the curve... you're pricing in three, maybe four hikes in there. We think that number's two, maybe three”at 31:29

Jason Draho · UBS Global Wealth Management

Enormous AI capex keeps rising next year and drives semiconductor earnings, mostly via price, not volume.

Jason says hyperscaler capex has been ramped up relative to the start of the year, and expectations are for it to rise further next year. This capex drives much of the enormous earnings growth. Semiconductor earnings could be up about 60% this year, but much of that is price appreciation rather than more quantity. His framework is an AI flywheel: productivity benefits drive demand for compute and tokens, which needs more investment. He watches for signs the gains aren't there, demand falling, or open-source models disrupting this.

“So there is obviously an enormous amount of CapEx spending. It's been ramped up relative to the start of this year... Numbers are expected to go higher next year.”at 23:51

Steve Chiavarone · Federated Hermes

AI build-out takes three to five years, with chips and power sold out, supporting earnings visibility through 2028.

Steve says data centers take three to four years to build, and a chip fab takes about three years. Chip makers have already sold next year's output, and heavy power equipment makers are taking orders for delivery in 2031. Because of this long lead time, capex announcements do not all finish immediately, and buyers of the next increment of supply will pay higher prices, which supports margins. He says this looks good through 2028. If AI innovation slowed, the benefit would shift from the bottleneck companies back to the spenders, rather than AI being abandoned.

“It takes three years, three, four years to get these data centers up. So when you think about the demand for the kind of hard assets and the industrial goods needed to do this build out”at 27:08

Jason Draho · UBS Global Wealth Management

Expects US inflation to fall, but persistent supply shocks could keep it reflationary.

Jason's base case is that inflation will fall, but he calls it the wild card. If it doesn't, the risk is a more persistent, reflationary environment rather than a soft landing. The mechanism he describes is a series of supply-side shocks that keep prices up, and strong demand would make that worse. This is one of several risks, and he is sympathetic to a strong-growth scenario.

“Inflation is sort of the wild card and that what we think it's going to go lower. If it doesn't, the risk is instead of nice kind of let's quote unquote soft landing, but something where it's just kind of persist to be somewhat reflationary.”at 6:06

Steve Chiavarone · Federated Hermes

High-end consumer and hyperscalers drive the economy and are least rate-sensitive given strong balance sheets.

Steve says the main drivers of the economy now are the high-end consumer and the largest mega-cap corporates, including the hyperscalers. He argues they are the least rate-sensitive participants because they have strong balance sheets and high cash positions. He sees this as durable, which is why he is not worried that rising yields will derail growth.

“the big drivers of the economy right now are the high end consumer in the consumer space and the hyperscalers and some of the biggest mega cap names in the corporate world. And they're the least rate sensitive participants in the economy because of strong balance sheets, high cash positions.”at 15:10

Steve Chiavarone · Federated Hermes

AI build-out is not a bubble; financing, spreads and rotation show rational, not euphoric, behaviour.

Steve says he is watching for 'sanity' and sees it. The healthiest hyperscalers finance themselves far more cheaply than secondary players, and debt spreads have widened modestly. In a bubble, he argues, everyone gets funded cheaply with no distinction between strong and weak borrowers. The hyperscalers have underperformed while the bottleneck names rallied, which he reads as a healthy rotation rather than buying everything. He does not subscribe to 'AI Armageddon', but says the debate about the right pace is useful. He concludes the boom is not yet a bubble.

“What are we watching to make sure that it's not a bubble? Well, we're watching for sanity. And we see that, right?”at 29:12

Steve Chiavarone · Federated Hermes

Overweight emerging markets; Europe is less exposed to the AI build-out and more exposed to energy risks.

Steve says the US and emerging markets are the epicentres of the build-out, and his firm is overweight both. Outside the US, he sees EM as the main exposure, since Europe has much less of it. He also points to Europe's greater energy concerns going into fall and winter, with low stockpiles, compared with US energy independence.

“The US is the epicenter of this build out as is emerging markets. And so we tend to like both of those.”at 32:08